Hello everyone. I'm Howard Schneider. I write about the Federal Reserve and economics for Reuters based out of Washington. Thanks for joining this conversation with Federal Reserve Governor Chris Waller. Chris joined the Fed in 2020 after being appointed to the Board of Governors by President Trump and has been one of the Fed's prominent voices on monetary policy and the economic issues and debates that drive those decisions. He was research director at the St. Louis Fed for about 11 years before that and an economics professor at the University of Notre Dame. Right before that, he was among a handful of people also interviewed by President Trump as a possible Fed chair. He and I will have a conversation and hope to cover a lot of ground. But before that, Chris has some prepared remarks to kick off the discussion. Chris, over to you.
All right. Well, thank you, Howard. To set the stage before we talk, let me give you a sense of my thinking as of today about the economic outlook and the implications for monetary policy. The short version is that while inflation remains meaningfully above the Federal Open Market Committee's 2% goal, recent data suggest we are finally seeing some signs of disinflation. Now, if this continues in the data over the next two weeks, I would be inclined to support holding the target for the federal funds rate at its current setting. But there continues to be considerable uncertainty about how military conflicts, trade policy, and artificial intelligence will affect prices and economic activity. If the incoming data for August show this movement has been fleeting, then it may be appropriate to raise the policy rate when the FOMC meets on September 15th and 16th. Now, after a description of my outlook for the economy and monetary policy, I will offer some thoughts on how I communicate those views to the public.
So, let me start with the real side of the economy. Despite the uncertainties I mentioned, most of which weigh on economic growth or economic activity, growth in real gross domestic product or GDP is continuing at a solid pace. Real GDP grew at a 1.8% annual rate in the first half of this year. Consumer spending growth was solid in the second quarter after a slow start to the year, while business investment has been strong throughout. Overall real private domestic final purchases, the measure of spending that best reflects the underlying strength of consumer demand, rose a strong 3% in the first half of 2026. Now, we have only limited data for the third quarter of this year, including July retail sales, which were weak, but this decrease reflected the fact that Amazon's Prime Day promotion was held in June, dragging down seasonally adjusted sales in July. Outside of non-store sales, retail spending grew. Given the rise in wealth from the increase in equity prices this year, I believe this should sustain consumption growth going forward.
On the business side, data center plans point to continued rapid growth in business investment associated with the ongoing buildout of AI and related technological upgrades. High-tech investment continues to rise at a rapid pace, and software investment, which some feared could be depressed by AI's coding ability, has grown near its long-term historical average. Now, some would argue that this investment in a narrow sector that tends to be capital intensive rather than labor intensive is misleadingly propping up GDP and should be in some sense discounted. I don't agree. AI investment is a legitimate part of GDP today, and I expect this technology to continue to be an important part of the economy after the buildout peaks and AI becomes as integrated into our lives as the internet has been. More broadly, one signal of continuing business spending growth was another increase in July in sentiment among purchasing managers for non-manufacturing firms to a level that I would also describe as solid. New orders for these firms, which represent the majority of businesses in the economy, continued to grow in July, and the index of supply problems continued to improve. Today we will get the August non-manufacturing survey, so we will see if this trend continues. Combining the various bits and pieces of the economy, I expect real GDP to grow a bit more than 2% this year, a respectable outcome considering all of the uncertainties I have mentioned.
Now turning to the labor market, it is also in satisfactory shape. While there were indications in the second half of 2025 of easing labor demand relative to supply, those signs have evaporated. Job creation, though a bit volatile, has increased this year by an average of 60,000 a month through July. That is close to and probably a bit above estimates of what it takes to keep pace with the slow growth in the labor force, mostly because of much lower net immigration. Payroll gains have broadened to most sectors of the economy in recent months, and the unemployment rate has fallen a bit to 4.1% in July, a historically low rate and slightly below the median of FOMC participants' long-run equilibrium rate. Layoffs and initial claims for unemployment insurance are likewise low. I expect more of the same tomorrow when we get the August employment report. With economic activity and the labor market in good shape, they are not a large factor in my determination of the appropriate setting of monetary policy, but they are an important backdrop for the part of the outlook that is my focus right now: inflation, and my judgment about how much the current stance of policy is working to return inflation to 2%. More about that in a moment.
Now, inflation is elevated significantly above the FOMC's 2% goal and has exceeded that target for 5 and a half years. In July, prices based on the personal consumption expenditures index, or PCE inflation, rose 0.2%, and core prices excluding food and energy increased 0.2%. While I was happy to see this monthly number for core inflation because it continued the pattern of lower monthly readings that we saw earlier in the year, what caught my eye in the last PCE report is that non-market services prices accounted for approximately half of the increase in core PCE prices. Now, as you are probably aware, I don't like throwing out specific categories going into the estimate of PCE inflation, but non-market services have always been an issue for me since they are imputed and are not actual price changes. So, ignoring this one factor, my take is that the underlying inflation is even doing better than last month's core numbers suggest.
Now, PCE prices are up 3.7% in the past 12 months and core PCE inflation is 3.3%. While it is important to acknowledge these 12-month increases for the real-world effect they have on businesses and consumers, they are not the best guide for where inflation is today. I say this because, notwithstanding uncertainty over the geopolitical factors that have raised prices, I don't see elevated energy prices and tariffs now as a significant source of ongoing inflation pressure. The evidence is that the price effects of tariffs have largely passed through inflation, and my earlier worry that higher energy prices would bleed into many goods and services prices so far hasn't come to pass. In the wake of these price shocks, to get a fix on the current trend for inflation, it is helpful to focus on more recent price increases, such as how inflation measured over the past three months has evolved over the year. To deal with the ongoing volatility in energy prices, I will focus on core inflation excluding food and energy, which is usually a good guide for inflation going forward. Now, three-month core inflation is 3.05% through July, a level that is still not consistent with the FOMC's 2% goal. Nevertheless, it is important to note the trend. Three-month inflation has fallen steadily from 4.76% in February to the 3.05% today. That's a large change in the three-month inflation rate. That is a considerable improvement, and the speed of this downward trajectory is encouraging.
One factor that I expect will lower reported inflation a bit is a pending change in the way the Commerce Department estimates the fees paid to stock market traders and related professionals. That change in this non-market price estimate, which I expect to be made shortly, could lower 12-month PCE inflation by a few tenths of a percentage point. Given my issues with non-market services pricing, I view this as a welcome measurement correction. Now, I do see some upside risk to inflation. Energy prices have moved up again and remain significantly higher than they were at the beginning of 2026, and the economy faces both pressure on technological goods prices related to the AI buildout and the possibility of more tariff increases. But in contrast to the period of high inflation after the pandemic, wage growth, once accounted for productivity growth, is broadly consistent with an expectation that inflation is continuing to come down to 2%. I am also attentive to the fact that public views about future inflation could rise after the long period of inflation above the FOMC's goal. Fortunately, the Fed has a very good record of making good on its commitments, and we haven't seen a significant increase in long-term inflation expectations, but it must be acknowledged as a risk, one that the FOMC should be prepared to act on if longer-term expectations begin to rise and progress on inflation reverses.
So, this leads me to my outlook for monetary policy, which I previewed at the beginning of these remarks. As of today, the labor market is stable with employment near its maximum sustainable level, and inflation is making slow but continued progress on reaching 2%. We will get another employment report tomorrow and another inflation reading before the next FOMC meeting. I don't expect that the employment data will deviate much from what we have been seeing, so my decision on the appropriate stance of policy will be heavily influenced by what we learn about August inflation. If there is continued progress towards our 2% goal, then I'm willing to support holding the policy rate at its current level. But if inflation comes in hot, I would consider a rate hike. I judge that policy is currently only slightly restricting aggregate demand, and it may not take much acceleration in inflation to nudge me into supporting tighter policy. If there is evidence that progress towards 2% inflation reversed in August, a small adjustment in our stance would help ensure that it resumes.
So by way of wrapping up, I want to speak about central bank communication, which I consider an essential part of the monetary policy process. I distinguish between three types of communication that matter for monetary policy and how I personally try to communicate my views to the public. First, I try to communicate why I have taken my current policy position. If I vote to hold rates steady, I explain how current economic conditions affected my policy decision. Now, I was comfortable supporting the FOMC's decision in late July to hold rates steady because the data at that time led me to view the real side of the economy as solid and we finally saw some hints that disinflation may be starting. So I was willing to be patient and see if the disinflation would continue.
The second way in which I communicate is to explain how future economic data will shape my future policy decisions. In short, I try to describe my reaction function. When thinking about future data, I communicate that if—get that word, if—the data comes in in a particular way, then I will advocate for policy to be set in a particular way. The key point here is that this is not a commitment to a policy action; it is a conditional policy statement. A different economic outcome would lead me to advocate for a different policy action. In my remarks today, I have outlined what it would take for me to support a continued pause, as well as what would cause me to support tighter policy. By communicating my reaction function, consumers, businesses, and investors can better understand how I will vote on policy given the range of outcomes and then factor that into their planning for the future. Now, is that reaction function perfect? No. But my years as a professional economist and policymaker have given me substantial knowledge on how policy should respond to shocks. In this sense, I view myself as a home plate umpire in baseball. The pitcher is trying to strike out the batter. The batter is trying to hit the ball or walk to get on base. Both want to play the ball, but they cannot do that until they know the umpire's strike zone. The strike zone is the umpire's reaction function. If the ball goes here, it's a strike. If the ball goes here, it's a ball. Now, the players don't expect the umpire to have a perfect strike zone; they just need a rough idea of its parameters and some guarantee that it won't change much on every pitch. Perfection is not needed for them to play well. So, when it comes to my reaction function, I do not let perfection become the enemy of the good.
The third and final type of communication is forward guidance, which specifies a path for the policy rate in the future that is essentially independent of incoming data. This type of communication is most warranted when the policy rate is at the effective lower bound and additional communication is needed to guide market expectations. For example, in September of 2021, it was clear to me that we needed to raise the policy rate to deal with accelerating inflation. But as this would only happen after asset purchases had stopped, I supported forward guidance and strongly signaled the end of those purchases, setting the stage for rate increases in 2022. By communicating to markets that rate hikes were coming and coming soon, market interest rates began to climb. By March of 2022, the two-year Treasury note had increased 200 basis points, and we hadn't moved the policy rate off the effective lower bound. So, in this example, forward guidance helped tighten economic conditions long before we actually raised the policy rate. But it is important to remember that those actions were taken when the policy rate was near zero. I agree with Chairman Warsh that forward guidance isn't appropriate now or in many other situations, but when it is truly needed, I believe it should be used. And with that, I think I've rambled on enough. So Howard, let's get to your questions, which I'm sure will be better informed than most of my answers.
Thanks a lot, Chris. We're going to relocate over here to the chair, so after you. Thanks again for that—detailed and provocative as usual. Let me start with this: this has put a lot of weight on CPI, and I'm sure that the Kalshi bets on CPI now are just going up and down and all over the place. So let's explicate that a little bit if we could. The PCE target—the target for 2% inflation is set using personal consumption expenditures. That runs different than CPI, so you've got to translate CPI to PCE. Give us a little more detail on what you'd be looking for September 11th on this next CPI release to say, "Yeah, it's going to be bad," or, "Yeah, it's continuing to get better."
Yeah. Once you get the CPI and the Producer Price Index like a day later, you have a pretty accurate idea of what the PCE number is going to be. So that's why we can focus on those two numbers, because they pretty much tell us what's going to happen. Now, I've argued for well over a year now that tariffs were going to roll off their one-time price level effect and that we would see by this summer a rapid drop-off in inflation. The energy price shock from earlier this year has created some uncertainty about that, but if you go back to like January 2025, PCE core inflation was like 2.3%. We weren't too far off, right? So if we get this roll-off that I've been arguing—and it's almost a full percentage point—then we should start seeing some pretty lower numbers. So I think that is what we should start seeing happening. As I said, so far energy has not bled into other goods prices. So my expectation is we will get reasonable CPI and PPI numbers in the next month.
Now, people are going to accuse me of being data-point dependent—I think you were already starting to do that—but what I try to point out is if you're only going to look at trend, you're always going to miss a turning point. Turning points are not captured by the trend; that's the whole idea. So once you get to what you think is a turning point, you have to put more weight on the near-term data observations if you want to catch that turning point. Now, the speech I gave in July, that was what I was trying to argue—that I thought we might be at a turning point on inflation. Either it could go up, but I thought it was going to start potentially turning down. Two numbers have come in, they look like that. I'm willing to sit and wait and be patient and see if a third one comes in. But if it reverses, then, you know, it's time to pull the trigger and hike rates.
So CPI-wise, will it matter core versus headline if—
Well, definitely core, because headline tends to be a bit noisy for thinking about where future inflation is going. It doesn't mean we should ignore energy or food—I never say that—but in terms of thinking where inflation is going, we try to take that out. Just the volatility of energy prices this year, that's a perfect example of why you should kind of look through headline and focus more on core.
Okay, so not to be too data-point dependent, but give us a benchmark for monthly, three-month CPI specifically. What level do you think would tilt you one way or the other?
Yeah. I mean, I'm just going to say if it comes in hot, and I'll let you define what hot is. Okay. Then it's like, okay, two is not enough. I mean, this has happened to us in the past. We got some soft summer readings, and then it kind of took off again. I got burned on that in 2024, for example. So I don't really want to put a numerical estimate, but if we get things that start looking like they're bringing down this three-month number—the three-month number is 3.05% now—if you get that thing down to like 2.8%, this is fine. Then you should just keep holding where you're at.
So let's talk about the PCE methodology change a second and also the index kind of that Chair Warsh gave us at Jackson Hole last week, that he was focused on what share of the PCE basket was increasing by more than 3%, right? So, A, is that index a good index? And B, what's the risk of moving in September being guided by this CPI number when the thing you're actually targeting, PCE, may have a revision two weeks after that that pulls it down?
Yeah, that's what I mean. We're all anticipating that the revision is going to drop this down. So if that plus what's actually happening in the data, you might see a significant drop in core PCE. So if it's 3.3%, it'll drop to like 3.1%. Then if you get some decent data, this thing goes under 3% on an annual basis and down on three-month even lower, right? So that's what I'm willing to take the chance to see. I'm going to paraphrase John Lennon here: give disinflation a chance, okay? And let's—we can wait one meeting. I just don't see why we have to do it. The mistake you run is if in fact we're at a turning point and disinflation is starting to happen like we've long thought it was going to, or I certainly long thought it would, you're raising rates into a disinflation. You're late at the—I mean, you're just or you're too far ahead of—you're depending too much on the past. So that's why I'm saying, look, what's the cost of waiting one meeting? Hiking 25 basis points one meeting right now is not going to bring the CPI down to 2%. So let's just—I think this is risk management. You want to take a chance to see if disinflation continues, but I'm not taking a big chance on it.
Sure. So July, when you were speaking to this, it felt like your default was kind of leaning towards hiking near-term. It feels like your default is kind of shifting towards—
Yeah. Because that's what I mean. Back in July, we had seen six months or so of just rising core PCE. Instead of coming down, it was rising. So there's where the trend was saying, "It's looking bad, so be prepared to go." But we got a soft report, and that was when it was like, can we wait one meeting to see if it continues? And I felt yes, it was. And that was validated. We got another reasonable soft read. Like I said, if you take out non-market services, that thing was like 0.12%, right? Okay, maybe let's see if we get another one.
Right. And just to be clear for the audience, these non-market services, for example, portfolio fees to brokers and things, which are a function of stock market prices, they're not supply and demand in the economy.
And it's quantities, too. It's just like saying, you know, if you buy more stocks, you're going to pay more. Their total fees go up. So you're mixing up price and quantity when you're looking at this. So that's why I applaud the efforts to sort of correct for this thing. In the past, this wasn't a big deal, but for some reason over the last year, it's been—I mean, this professional financial fees is like almost all of that increase in non-market services prices. So scratch your head if you're going to let one thing drive half the PCE and it's not even actual measured price, right? Maybe you want to just say, let's kind of push that aside. And I hate doing that, but this is one of those times I think it's worth at least keeping an eye on.
Let me get to a couple other aspects of what you just said relevant to the inflation discussion. Growth of 2% plus is good for this economy; it's above long-term trend, right? So I guess the question is, is this a non-inflationary type of growth, or is this stretching the output gap to the point where you feel underlying pressure in the economy is towards higher inflation because we're stretching our productive capacity?
Yeah. I mean, if you are increasing your productive capacity, potential output goes up, and that is not inflationary, right? I mean, this is not something new that the Fed has discovered. The Fed research staff have done this forever. So when you take output growth, you look at potential and then you say, "Where are you relative to potential?" So if potential goes up and it's closer to actual, then the output gap, or what we say the excess demand, is not that bad. So you could see disinflation even with reasonably good growth.
So you feel that the potential is rising at this point?
I think it is. We've seen it for the last few years. We've seen growth go up, productivity has gone up for lots of reasons besides AI. This started before AI. AI is probably going to down the road at some point do it. I think it's an amazing technology. I watch my wife vibe code all day long; it's just amazing what she can do with this.
What's her best program so far?
I can't tell you. I don't want to commercially advertise what my wife's doing, so I'll probably get arrested. But I just watch what she does with it, and it's just really fascinating to me what she can do with the coding and stuff. So I do think it is. I mean, I heard a joke recently that's a paraphrase of Robert Solow's line: we see AI everywhere except in the bottom line of firms' profits, right? You know, so at some point we think that'll show up, but it hasn't shown up yet.
So another aspect: you mentioned that you don't think the current setting of monetary policy—a little bit restrictive, but not all that much. You and the Chair seem to be in alignment on this; this is what he said at Jackson Hole: "Current policy doesn't seem to be restricting anything." So that's a lot of weight on an opinion that would seem to indicate, well, maybe you need to hike.
Yeah. I mean, I've said this before: there's a difference between financial conditions on Wall Street and financial conditions on Main Street. Mortgage rates are not low, right? Auto loan rates are not low. Main Street of America is staring at credit spreads and corporate bond rates; they're looking at, "What does that do for me?" I mean, I don't get it. So I've made this argument in the past that what looks like loose financial conditions is really a reflection of stock market prices. I look at macro data; that's what I care about. And if I see housing's in the tank, new cars have gotten almost to be a luxury good instead of a normal thing that a middle-class family can do, that's not loose financial conditions. And most of the stocks are not owned by the lower half or lower three-fourths of the population; they're all held heavily by the upper 25% of the income distribution.
So given that kind of differential outcome across households, you're open to the possibility that the current level of policy might get us back to 2%?
Yeah, I think so. At least let's take a chance and see. Like I said, I'm not going to say let's wait till next year, but let's just wait and see if we get some improvement on this.
Let me move if I could to—I think that's pretty clear.
Anyway, bond markets, rising yields. And let me start, like I know you all don't do fiscal policy, but just as a kind of less-informed to more-informed, taxpayer to taxpayer, what do you think about the US debt right now? Because—and I want to give some context—everybody in your shoes always says, "$40 trillion, 6% debt to GDP, $3 trillion a year being paid to interest right now. This is not sustainable." "Unsustainable" is a very strong word, but it's also kind of an empty one because it begs the question: over what timeline, right? So are we at the cliff or not? And if not, where is it?
