Investing.com -- Beth M. Hammack, President and Chief Executive Officer of the Federal Reserve Bank of Cleveland, has recently observed a mix of economic signals. While some retrospective data appears promising, uncertainty surrounding government policies clouds the economic outlook, posing risks of higher inflation and slower growth.
Entering this year, the economy had solid momentum, with real gross domestic product increasing at a 2-3/4 percent annualized rate during the second half of last year. However, data for the recently concluded first quarter suggests a slowdown in growth as consumers and businesses have become more cautious. National surveys show a decline in consumer and business sentiment, with many attributing policy uncertainty as a significant factor.
In the Cleveland Fed’s region, economic activity is reported as subdued, with many businesses pausing spending due to uncertainty around government policies, including tariffs, immigration, federal spending, and employment.
In terms of employment, the U.S. labor market has been healthy, with the unemployment rate at 4.2 percent in March, a relatively low level, and similar to its readings over the last 12 months. Solid job gains were observed through the first three months of this year.
On inflation, more work needs to be done to return the economy to price stability, defined by the FOMC as 2 percent inflation in the Personal Consumption Expenditures price index, or PCE inflation. Headline PCE inflation was 2-1/2 percent through February, and core PCE inflation, which excludes the volatile food and energy sectors, was somewhat higher.
Changes in tariffs have been prominent in the news over the last two weeks, constituting a substantive change in trade policy. The overall economic effects of these recently enacted and other proposed changes to government policies will take time to become clearer.
Financial markets have been volatile in recent weeks, as they incorporated this news into various asset prices. Financial conditions have tightened on net, as major equity indices have declined, credit spreads have widened, and longer-term interest rates have increased. At the same time, the dollar has weakened against a basket of foreign currencies.
Given the economy’s starting point, and with both sides of the Federal Reserve’s mandate expected to be under pressure, there is a strong case to hold monetary policy steady in order to balance the risks coming from further elevated inflation and a slowing labor market.
With inflation elevated, the current modestly restrictive stance for monetary policy is appropriate to continue the downward pressure on inflation so that it returns to the Federal Reserve’s goal in a timely fashion. If the economy falters and inflation declines, then it may be appropriate to ease policy by lowering the federal funds rate from its current level of 4-1/4 to 4-1/2 percent, perhaps even quickly.
However, if elevated inflation is paired with a slowing labor market, then monetary policy will face some challenging tradeoffs. In that case, it will be important to ensure inflation expectations remain well anchored while assessing the likely magnitude and persistence of the misses to each side of the Federal Reserve’s dual mandate goals.
Setting monetary policy requires careful consideration and courage. The Federal Reserve is in a position to assess the incoming data, the risks to the outlook, and the appropriate policy response to achieve its longer-term objectives.
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