Inflation remains above target.
Dr. Bill Conerly using data from Bureau of Economic Analysis
Jerome Powell hinted that the Federal Reserve would cut interest rates at its meeting September 16-17, 2025. Financial markets figure there is an 86% probability that the Federal Open Market Committee will cut the Federal Funds rate by one-quarter of a percentage point (as of this writing). But that one-seventh chance of no change deserves consideration. Continued inflation above the two percent target argues strongly for no change in September, or indeed through the end of the year.
Inflation Remains Above Target
The Fed’s preferred measure of inflation (the Personal Consumption Expenditures Excluding Food and Energy) has never come down to target. Inflation dropped sharply from its 2022 peak, but the Fed never got the rate down to two percent. In the 30 years prior to the pandemic, actual inflation was within a half percentage point of the target a majority of the time, with a long streak below target. So the target is attainable.
Tariffs complicate the inflation calculation. Past Fed studies concluded that it would be best for the Fed to ignore changes in prices caused by tariffs. They would likely be one-time shifts in the price level that do not trigger higher inflation year after year. For a rough calculation, begin with the inflation rate before President Trump took office: 2.9%, after ranging between 2.6% and 3.1% in the preceding year. It was stable but above target.
The seven readings we have so far in 2025 all lie in the range of 2.6% to 2.9%. On the surface, inflation seems not to have changed. Calculations based on tariff revenue suggest prices might have jumped up by 0.6% recently, if they were completely passed through to consumers.
Although complete pass-through is likely in the long run, it’s very unlikely in the short run. Sellers may have cut prices by about half the tariff so far. (That, though, will not last very long.)
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At the next Fed meeting, advocates of cutting rates can make a case that underly inflation is dropping when we consider tariffs and the dollar decline on foreign exchange markets. It’s still above target by any calculation, but maybe moving in the right direction. Economists at the Fed are running the numbers in much more detail to arrive at their own estimate of underlying inflation.
Employment Remains Solid
The unemployment rate has been roughly level for the last 12 months, most recently 4.2%. It had been a little lower, down to 3.4% once, in 2022 and 2023. That rate was generally considered unsustainable. Unemployment is never zero because it takes time for job seekers and employers to find good matches. The Congressional Budget Office estimates the natural rate of unemployment to be 4.3%. This is the unemployment rate “arising from all sources except fluctuations in the overall demand for goods and services.”
CBO also estimates the potential level of GDP. Actual GDP is less than one percent below potential, and unusually low spread.
Economists usually look at new jobs, but immigration is now very low, making that figure useless as a measure of how the economy is doing.
Layoffs have made some headlines, but the total number of people filing for unemployment insurance is unusually low. The number of voluntary quits and layoffs are level, with hires down slightly.
Rolling all of the labor data together, the economy is in good shape right now, certainly not bad enough to justify easier monetary policy. The Fed believes, though, that current interest rates are restrictive, so the economy will slow if nothing is done.
Economic Forecasts Best Argument For Rate Cut
Economists mostly anticipate rising unemployment. The Survey of Professional Forecasters, compiled by the Federal Reserve Bank of Philadelphia, sees unemployment rising to 4.5% by mid-2026. That is not at all a worrisome level, but a small interest rate cut would be appropriate. We cannot place too much weight on economic forecasts (and this is being written by a forecaster), but they should not be totally ignored.
A quarter point cut in the overnight interest rate won’t make much difference to the economy, though a whole string of quarter-point cuts could.
Why The Fed Focuses On Inflation
Many wonder why the Federal Reserve focuses so much on inflation. In the short run, it seems like layoffs should be more important than inflation rates. But economists have looked at the long-run implications of different policies. Suppose one doesn’t care a bit about inflation but wants a good labor market: jobs available for those who want them, with very few layoffs. What economic environment creates that happy labor market?
Low and steady inflation rates bring low and steady unemployment. This is a conclusion based on multiple studies of both U.S. economic history as well as foreign countries. In the short run there may be an inflation-unemployment tradeoff, but over time there is none. We can get both low and steady unemployment when we seek low and steady inflation.
Given the uncertainty of economic forecasting, there will probably be voices at the Fed’s next meeting arguing against a rate cut at this time, for all the reasons cited above. And for the underlying reason that low inflation is incredibly important for a healthy labor market.