I'm getting a Microsoft L download in the middle of my speech here. You got to be kidding me. Hang on. It's slowly coming. Hang on. Uh, technology. It always fails just when you need it. Few more seconds. No, it's not. It's just downloading. It's just downloading app update. There we go.
All right. Sorry for the delay. Good morning, especially for all those brave souls in the US who may have woken up at 4:30 to listen to me. I want to thank the Central Bank of Turkey for the opportunity to speak to you. I look forward to today to hearing perspectives on the global economy and Turkey's role in it. But I thought the most constructive use I can make of the valuable time you have granted me is to offer a brief update on the US economy and then offer some thoughts on central bank communication, as our last panel just talked about.
So, as you know, in September, the Federal Open Market Committee or FOMC voted to raise our policy rate 25 basis points to 3.75 to 4% after 9 months during which we held the rate steady. When monetary policy changes in this fashion, one question that most people ask is what comes next? And I promise I'll do my best to answer that today. But first, I will address another question raised by this shift in policy, which is what changed? Was there new evidence or did my thinking about the economy change? It turns out the answer to this second question has a lot to do with the first one, about where policy goes from here.
Now, I've mentioned that last month's increase in the federal funds rate came after nine months of holding it steady. When I ask what changed, I'm obviously asking what changed in the seven weeks between July 29th when the FOMC voted to hold rates steady and September 16th when we raised them. But I'm also asking about what changed from the second half of 2025 when the FOMC reduced the policy rate 75 basis points over three consecutive meetings. While it might seem to some that monetary policy turned on a dime in September on one or two data points, in my case, my decision last month was a culmination of factors that developed over the past year, and I'd like to describe them.
When the FOMC cut rates from September through December of 2025, we did so with inflation fairly close to our 2% target after accounting for tariff effects that research found were passing through official measures of inflation. At the same time, there was significant evidence of a weakening labor market with an increase in unemployment over the first eight months of last year and very low job creation. Though the picture was less sharp after official data was interrupted because of the government shutdown that began on October 1st, 2025, other data supported the view that the balance of risk to the FOMC's employment and inflation goals seemed clearly skewed toward employment. I considered our cuts to the policy rate last year as insurance against an economic slowdown.
But then over the course of the first half of this year, the labor market appeared to stabilize while progress on inflation stalled due in part to the conflict in the Middle East that drove energy prices higher. I supported no change in the policy rate in the spring and summer with the hope that the conflict would end soon and that the oil price surge would not have a lasting effect on inflation. And there were some signs of an easing of inflation over the summer. While headline inflation seesawed up and down based on movements in oil prices and the state of the Middle East conflict, core personal consumption expenditures or PCE inflation, which excludes volatile food and energy prices, moderated to 0.1% in June and an initial estimate of 0.2% in July. That was later revised down to 0.1.
But other forces were undermining my faith in this progress. First, hopes for a quick ending to the Middle East conflict faded, and experts warned that low inventories and damaged infrastructure could keep oil prices high through the rest of the year through 2027. Second, evidence mounted that the artificial intelligence buildout was significantly driving up high-tech consumer prices and projections for the size of that buildout ballooned. Third, continuing trade conflicts threaten new tariffs that could put upward pressure on inflation yet again. In most cases, these were forces that became clear as the year passed, swamping the fleeting sign of progress towards 2% inflation.
When the first inflation reading for August came in hot just before the FOMC September meeting, it was impossible to deny that inflation was still too high and not making sufficient progress back to our 2% target. So while some suggested that monetary policy shifted in September based largely on a single data point of consumer price inflation in August, I hope it is now apparent that wasn't the case for me. Instead, it was a preponderance of evidence over several months that the risk for monetary policy had shifted, reflecting a strengthened labor market and a range of persistent inflationary forces. For me, this led to the judgment that the policy setting that the FOMC maintained from December 2025 through September of this year would not be sufficient to bring inflation back down to 2% in a timely manner.
My decision to change the stance of policy emerged over time because it's not one that I take lightly. With evidence that economic activity is strengthening in the second half of this year, I am not greatly concerned that tighter monetary policy threatens a damaging slowdown in the US economy. But I am concerned about the recent acceleration in inflation after what soon will be five and a half years of inflation above our target. This will lead consumers, investors, and price-hitting businesses to revise up their expectations for future inflation if we don't start bringing it down.
Now, based on some key data released last week, I see the economy in roughly the same place as it was at the time of the FOMC September meeting. While the number of jobs created was down overall, the employment report indicated the labor market continued to be solid and stable in September. The unemployment rate remains relatively low and near the median of policymakers' projections of its longer-run level, while payroll gains are in the range of estimates for break-even to keep the unemployment rate steady. August inflation data, which included revisions to the government's methodology, showed monthly core PCE inflation of 0.25% and the 12-month change at 3%.
So looking at the history of 12-month core inflation, it has been roughly between 2.5% and 3% since the spring of 2024, two and a half years. This is obviously higher than we want, above our target and not showing sufficient progress. So overall, the new data reinforced my view that the labor market is stable and inflation is too high. For at least the near-term, policy will be focused on the inflation side of our mandate.
So for the remainder of my remarks, I want to discuss a particular way of communicating the expected future stance of monetary policy that has the flavor of forward guidance but isn't forward guidance. So, let me illustrate what I have in mind with an example. Suppose that a majority of FOMC voters decide that policy needs to be more restrictive and that it is fairly clear to the public that some tightening is likely. What needs to be determined by both policymakers and markets is the number of rate hikes and the pace of rate hikes. Each policymaker thinks about his or her anticipated appropriate policy path to assist them in moving the economy toward the Fed's dual mandate. Markets estimate what the FOMC voters believe is the appropriate path of policy to assist them in pricing various assets.
So here's the question. How could policymakers communicate the expected policy path to markets? There are several options. So to help me get this idea across, let's assume the number of hikes that policymakers have in mind is three 25 basis point hikes, so that they anticipate policy will ultimately need to be 75 basis points higher than it currently is. Now the first approach policymakers could take is to say nothing about the expected path of the policy rate. Just do it and don't explain. But that approach could surprise markets and create volatility. Without additional information for the markets, in an extreme case, they could either price in zero future hikes or five more future hikes in future meetings.
And the point of that is with too few or too many hikes priced in, the change in financial conditions could mean too little or too much of an effect on economic activity than is desired by policymakers. Second, policymakers could use a strong form of forward guidance and communicate their support for raising the policy rate. Suppose they were to say every other meeting by 25 basis points until 75 basis points worth of hikes has been enacted. So you've given the total amount, the increment and the pace. That would be very strong forward guidance. So the market would clearly respond by pricing in 75 basis points of hikes over the next five meetings.
While this eliminates any uncertainty about the future path of policy, it ignores the possibility that incoming data would suggest going faster or slower or hiking by more or less than 75 basis points. So indeed, locking in a policy path over such a long period is unlikely to lead to good outcomes either, given that uncertainty about how the economy will evolve over time. Finally, there is something in between these two approaches that I will call the signaling option.
What I have in mind is that policymakers could signal that the policy rate is likely to be 75 basis points higher over some time interval. Let's just arbitrarily say 6 months. However, policymakers do not say what the pace of hikes will be or how large of an increment this will be done. And we can emphasize that the course of monetary policy is not predetermined and will depend on incoming data and its implications for our dual mandate goals. So this approach provides some information regarding what the likely terminal rate will be after hiking but allows the pace and size of rate hikes to be data dependent. Simply put, policymakers could signal where they are likely to be headed while acknowledging that there is no fixed final destination except for the achievement of our dual mandate goals.
So I see Federal Reserve policymakers' communications fitting in this last signaling approach both in their public remarks and their quarterly submissions of economic projections. The Summary of Economic Projections or SEP is serving that signaling role for policymakers. So for those who aren't aware, the SEP, all the policymakers submit kind of forecast for unemployment, GDP, inflation over the next one, two or three years and then what they think the appropriate path to the policy rate would be. So that's what this SEP does.
The projection submitted at the September meeting showed that a large majority of FOMC participants believe it will be appropriate to raise rates at least one more time this year. 16 of the 18 participants who submitted dots anticipated at least one more hike during the two remaining meetings this year. But four of those 16 expected two additional hikes this year. It gets a little more complicated reading the dots for the full year of 2027 since they ask what you think it'll be at the end of the year. And that could mean you could see hikes at the beginning of the year followed by cuts later in the year. You don't really know from the SEP what that timing and sequence looks like.
But eight participants expect that rates will be 50 basis points higher at the end of 2027 than they are today. So between the SEP and policymakers' outlook speeches that encompass their interpretation of additional economic data, markets have interpreted that the committee is likely to raise the policy rate 50 basis points in the coming months. But they don't know exactly when. According to futures markets prices for the federal funds rate as of yesterday, traders see an 85% chance of at least one more hike by the end of FOMC's December meeting and nearly 20% chance of two hikes in the next two meetings. And by the March 2027 meeting, markets see nearly an 80% chance of at least two more hikes and a 33% chance of three or more hikes.
So this signaling helps to anchor the path of short-term interest rates but provides flexibility in adjusting rate hikes based on incoming data. So if the economic data continue to come in as expected, I anticipate additional hikes to support a timelier return of inflation to our 2% goal. But there's some flexibility about when those hikes will occur. The hikes do not need to come at consecutive meetings, but they should be in place in an acceptable period of time. So, I think I'll stop here to make sure there's enough time for some discussion and Q&A. Thank you very much.
Yeah. So this is the million-dollar question right now that everybody wants to know. Why are yields going up? I would say theoretically there's many possible causes. One is if you have good strong expected real growth, firms have good productivity. They can afford to pay higher real rates and lenders know that. So if you have good growth projections, that could be a cause. And that's what we're seeing with the AI buildout, at least in the US. It also could be higher inflation expectations. You somehow don't believe the central bank will actually carry through and keep inflation down. And that gets built in to rates. Like I said, these are just the theoretical explanations.
There's also expectations that the Fed will actually, at least in the US, the Fed will raise rates in the coming meetings and that will push up longer-term rates as well. There's the AI buildout. For the first time in a long time, there's a lot of demand for funding and governments are potentially having to compete, at least in the US, with AI firms who are borrowing potentially trillions of dollars over the next few years to do the AI buildout. So that's it.
And then one last thing for the US, a lot of academic evidence has shown that the convenience shield or safety liquidity premium that has gone along with US bonds for 30, 40 years has disappeared. No longer do they view it as this special asset to be held for safety and liquidity. And that's going to end up driving yields up, too. So those are all possible explanations. I'm sure I missed a few in there too, but then it comes down to quantitatively which ones have the biggest effect and a lot of research is showing it's for the US, it's a lot of the real growth effects and there's some uncertainty in there that drives it and the AI buildup, that those seem to be the major drivers. It's not inflation. You look at market inflation expectations, they're anchored. It's not that there's any lack of credibility on the central bank that we're going to get inflation down. So, it's really those seem to be the two biggest ones that I'm seeing from empirical research.
So, I'm actually an AI optimist from what I've seen people do with it, including my wife who uses it every day for building websites and apps. It's just an astounding technology. I mean, it's just, it cannot be a fake. That's the way I look at it. This is definitely going to impact how we do our jobs, how fast we can do our jobs, how much output we can get done with all the extra output. So I think it truly is a revolutionary technology that's going to increase productivity for years to come.
When that productivity shows up, it's not obvious. We see it in anecdotes, but we don't see it in the aggregate data quite yet. It is going to have an impact on jobs, but we've known that about every technological change that's ever happened. Some jobs disappear, new jobs are created. I made this in a speech earlier last year, was what's kind of frightening about AI is the speed at which it's happening. In the past, these technological changes came in. We could see what jobs were going to disappear, but then it came in slow enough you could see which new jobs were coming on. Right now, we're seeing which jobs will go away, but we're having a hard time seeing what are the new jobs that are going to come in. And that's I think what has people kind of very, very nervous.
But I think in the end this is the real deal in terms of technology. Now, who's going to win in the end? Will it be the proprietary models? Will it be the open-weight models? It just depends. Will it be a market where there's one winner that takes it all and the rest of the firms fail and all their investment goes to waste? Or is it just going to be a huge market that everybody gets to have a share of? I think it's probably the latter. So I don't think it's going to have some big dramatic downturn on the economy, but it is going to be an amazing productivity-enhancing tool in the years to come.
