SPE Annual Dinner 2025 - Christopher Waller

I was but— actually cutting edge.

All right. Well, thank you Dave and thank you to the Society for the honor of addressing your annual meeting. It's quite the crowd, kind of overwhelmed, plus in a beautiful room. In doing a little research on the SPE's history, I noted that one goal cited by the business economist who founded this group was creating a forum to discuss the divergence between real world challenges and economic theory. That task is pressing when business profits, losses, and the jobs of employees are on the line, and stakes are also high for economic policy makers who face those very challenges today. Now economies are confoundingly difficult to understand. I almost read that as economists confoundingly difficult to understand, because in a sense they are the largest and most complex things ever created by humans. Economists try to make sense of this complicated world and explain it in logical and clear terms how to understand it. We develop rigorous theories that yield testable hypotheses, and we test those hypotheses to see if they are supported or rejected by the data. Being both an economist and an economic policy maker, my objective today is to follow in that tradition and use economic theory and various types of data to describe my outlook for the US economy and my views on the appropriate course of monetary policy. If any of you stayed tuned in to see if I talk about stablecoins or skinny payment accounts, I'm not going to talk about them today. So, it may seem odd to come all the way to London to speak about the US economy, but I hope it will be of interest. And I did warn the organizers that that's what I would talk about. Monetary policy makers like to use forward guidance to avoid surprises. So formulating my outlook has been complicated recently by the 43-day government shutdown, including the agencies that produce key economic data. As I will argue, I believe the challenge presented by this missing data has been overstated in many quarters. Policymakers and forecasters are not flying blind or in a fog. While it is always nice to have more data— who doesn't want more data? —as economists, we are skilled at using whatever data is available to formulate forecasts. Despite the government shutdown, we have a wealth of private and some public sector data that provide an imperfect but perfectly actionable picture of the US economy. So what is that data telling us? First, that the labor market is still weak and near stall speed. Second, that inflation through September continued to show relatively small effects from tariffs and supports the hypothesis that tariffs are having a one-off effect raising the price level in the US and are not likely to be a source of persistent inflation. Accounting for estimated tariff effects, underlying inflation is relatively close to the Federal Open Market Committee's 2% target. Third, despite realized inflation running close to 3% and above target for 5 years, medium- and longer-term inflation expectations remain well anchored near our 2% target. And lastly, even excluding the temporary effects of the shutdown, growth in real gross domestic product (GDP) has likely slowed in the second half of 2025 from its pace in the second quarter. This reading of the data leads me at this moment to support a cut in the FOMC's policy rate at our next meeting on December 9 and 10 as a matter of risk management. As I will discuss in more detail, risk management in fact provides some practical guidance in dealing with two questions that seem to have flummoxed some people: Is the job creation slowdown in the US this year mostly supply- or demand-driven? And how should monetary policy respond? Before I delve into that outlook, I'd like to say a bit more about data availability. The official sources delayed by the US government shutdown are important but by no means the only source of information for Fed policymakers about the economy. At any time, my colleagues and I rely on a range of data to form our views on economic conditions and the outlook. That can be hard data such as official government statistics or soft data gleaned from surveys or conversations with a variety of people. Often different sources of data— the hard and the soft data— are consistent with each other, but at critical times they can conflict. When that happens, it takes our skills as economists to try to reconcile this conflict. So let me cite two examples of my own experience to illustrate this point. First, back in 2022, the Fed was combating rampant inflation, as were most central banks in the world. And this required large and rapid increases in our policy rate. Now, standard Phillips curve models predicted that this would cause a sharp slowdown in economic growth and high unemployment. However, I had more trust in the Beveridge curve, which relates the unemployment rate to the job vacancy rate, as my guide to thinking about how the labor market would respond to those large rate hikes. I argued that we were on the steep part of the Beveridge curve, which meant that we could tighten policy, and that the brunt of that policy would be borne by a decline in job vacancies, not a rise in unemployment, as many predicted. Now, a critical assumption I made in this analysis was that a spike in layoffs would not occur. This assumption was very controversial since previous hard data showed that this was not the typical outcome. But all of my business contacts— the soft data, my anecdotes— everybody that I talked to told me that after the COVID-19 pandemic they had no intention of letting workers go if aggregate demand eased. This soft data helped convince me that my view of the labor market was correct and subsequent hard data coming in over the next two years confirmed my theoretical prediction. The second example of reconciling conflicting data is from this past summer. From late spring through June, the soft data, including anecdotes from business contacts, suggested the labor market was in a no-hire, no-fire equilibrium. Firms repeatedly said they were holding off on hiring for a variety of reasons I won't cover. Yet, the hard data at that time indicated a very robust job market with job creation rising from a monthly average of 110,000 in the first quarter of this year to 150,000 in the second quarter of this year. Now, it was clear to me that once again something wasn't right with the labor market. Despite the official data, what you heard and what you read were two different things. After the June FOMC meeting, I said that the labor market was more fragile than the hard data indicated and that the Committee needed to cut the policy rate to head off substantial weakening in the labor market. This was clearly an out-of-consensus view that raised more than a few eyebrows. But when the July jobs report was released on August 1st, the second quarter jobs numbers were revised down dramatically from an average of 150,000 per month to 64,000 a month, which vindicated my view. So once again, the soft data gave a better signal of the state of the labor market than the hard data. Now, let me turn to the outlook and I'll start with US economic activity. In my last speech, I discussed an apparent conflict between some forecasts of GDP growth in the second half of 2025 and the story that the labor market is weakening. Now, in the absence of more official data, but with additional private sector forecasts and surveys, it now appears to me that economic activity is not accelerating and therefore is tracking more closely with the weak labor market data than appeared to be the case when I spoke on October 16th. For example, private sector forecasts as seen by the median of respondents to the Blue Chip Survey are pointing to real GDP growth for the second half of this year that will be close to the modest first half pace and a significant slowing from the pace of last year. Now, of course, one factor lowering economic growth in the fourth quarter is the shutdown, which lasted longer than many expected. I continue to assume that any loss in real GDP growth in the fourth quarter will boost growth by roughly the same amount early next year. But besides that one-off boost from the shutdown, a possible warning about future economic activity is coming from the University of Michigan Survey of Consumer Sentiment. While over the decades this survey has not been closely correlated with near-term spending, large and persistent drops in consumer sentiment have occurred heading into recessions. In the United States, personal consumption expenditures are about 70% of GDP. So, a slowdown in spending has dramatic implications for GDP growth. The Michigan Survey is down significantly since July and fell unexpectedly sharply in October to near its record low reading. This dour view expressed by consumers, which may have been affected by the shutdown, lines up with what I'm hearing from US businesses, which reports slackening demand from middle- and lower-income consumers. One interesting detail from that survey is that deteriorating consumer sentiment was widespread among different demographic groups with the exception of those who own stocks. While the booming stock market is supporting spending by a narrow band of well-off consumers, it does not reflect financial conditions for most Americans, and that is a vulnerability for the economy. The rise in the stock market is substantially driven by artificial intelligence-related businesses that only account for a small share of employment. Even as AI's share of stock market growth and corporate profits grew significantly from 2021 through 2024, employment in AI-related firms held steady at less than 3% of non-farm employment. While I believe AI will create jobs in the medium term, the AI boom on Wall Street isn't doing so yet. A factor that I believe will weigh on spending in the coming months is that most households are facing strains in purchasing large assets such as housing and autos, in part because of the expense. While home price increases have slowed recently and even declined in some parts of the US, prices rose significantly in the previous few years. That is especially true for lower-value homes, which is making it harder for first-time buyers to enter the market. Although mortgage rates have declined a bit this year, they are still above 6% and much higher than the average for the decade or so before rates began rising in 2022. Housing affordability is near a record low. Since 2020, in just 5 years, the income needed to afford a median-priced home has risen by 50%, while median income through 2024 is only up 26%. And while the growth of mortgage debt has slowed, that in part reflects how high mortgage rates are weighing on the demand for mortgages. Returning to auto loan growth, it has been relatively weak this year, likely reflecting a combination of weak demand from households and pressures in car affordability. To a greater extent than housing, the cost of purchasing an auto mostly reflects the price, but interest rates play a factor in the monthly payment. Auto loan rates continue to be elevated relative to their average in the years before the pandemic. For example, in 2019, the average 5-year loan carried a 5.3% interest rate, whereas the average is now 7.6%— almost 50% higher— reflecting the combination of higher auto prices and interest rate expenses. The weeks of median income needed to purchase an average new vehicle remains elevated, rising from 32.8 weeks in November 2019 to 37.4 weeks in September this year. So to sum up, I consider the cost of housing and autos to be an ongoing challenge for consumers, especially lower- and middle-income consumers. This is likely weighing on spending growth and would become a more acute problem if the labor market continues to weaken. Now, let me turn to inflation, which even with the delay in price data, is the more straightforward side of the FOMC's dual mandate to discuss. 12-month consumer price index inflation through September was 3%. And estimates are that inflation based on personal consumption expenditures (PCE) inflation, which is the FOMC's targeted measure, was about 2.8%. Tariff effects have been smaller than many forecasters expected, and the fraction borne by consumers will only modestly boost inflation— an effect that has been quite gradual so far because of the slow drawdown of inventories that were built up in anticipation of tariffs. Despite inflation that has been above target for five years, inflation expectations are well anchored in the medium and longer run. To me, this shows that financial markets understand that they need to look through one-time price level shocks, and they have confidence that the FOMC will achieve its 2% target in the medium term. With the evidence of slower economic growth and the prospect of only modest wage increases from the weak labor market, I don't see any factors that will cause an acceleration of inflation. Now, let me focus on the side of the FOMC's economic mandate that has more of my attention: maximum employment. In the absence of federal data on the labor market, states have continued to report on initial and continuing unemployment insurance claims, and private sector sources have continued to publish their data as well. While there are methodological differences in these private data— some of them are less than comprehensive and some do not meet the strictest statistical standards— the private data do contain useful information. According to the Labor Department, we know that job creation in the US stalled from May through August. And with expected revisions that have been previewed and will become official next year, it is likely that employment actually was negative during that same period— employment growth was negative. A private sector measure of job creation that has continued since August, produced by the payroll services ADP, mirrored the drop in official data from May through August, reporting a monthly average of 27,000 jobs created over that period compared to the 143,000 a month that ADP counted for the six months up to May. So while the numbers don't line up, the direction is the same and the magnitudes are large. While the ADP data are quite volatile and have some other shortcomings that make them less reliable than government statistics, I do think these data are telling us something. And in September and October, ADP reported that businesses created a net total of only 6,500 jobs a month. And the latest weekly data that they are now releasing is even weaker. So slowing labor demand is also being echoed in surveys of employers and workers. There has been a steady decline this year in the Conference Board index of job availability reported by employers and workers. Fewer small businesses are saying it is hard to fill jobs according to the National Federation of Independent Business. I hear this all the time: nobody has trouble hiring; plenty of people applying— no problems. Meanwhile, job postings by Indeed continued to drift lower in October. A new survey of large employers found that these companies are predicting that 2026 will be the worst job market for new college graduates since the pandemic year of 2021, when the unemployment rate was around 6% at graduation. One series of government labor market data that we do have— continuing state-level claims of unemployment benefits— have risen on net in recent weeks and are running above levels in 2023 and 2024, although they are still fairly low by historical standards. This increase reflects the fact that it is taking unemployed individuals longer to find jobs than in the recent past. This is consistent with the well-known news lately about large corporate layoffs. Such announcements are anecdotes and may not be fully reflected at least in initial unemployment claims, but the numbers are eye-popping. The staffing firm Challenger, Gray & Christmas reported announcements of 150,000 job cuts in September and around 1 million so far in 2025, which is up 65% from last year. These are not small numbers; these are not small changes. By all accounts, many businesses may be cutting jobs or allowing levels to fall by attrition in connection with actual or anticipated productivity gains from AI. Now, as you know, there is a vigorous debate in the US about whether the low job creation numbers are the result of declining labor supply or declining labor demand. Simply looking at job creation numbers isn't sufficient to answer the question. One must look at other data that corresponds to these changes from standard theory. To help sort things out, let's think about a standard supply and demand graph— you're all economists, you should be able to do this. Consider a situation where there's a decline in labor supply that is greater than the decline in labor demand. This would shift the supply curve inward more than the demand curve. The result would be a reduction in employment, which is exactly what you see, which is why people call this just a decrease in labor supply. But it would also lead to upward pressure on wages due to labor shortages. We would also see an increase in job vacancies and a higher quits rate as employers chase higher paying jobs. Furthermore, workers should be reporting that job availability is increasing and firms should be saying that it's becoming more difficult to hire workers. Now consider the opposite situation: a contraction in labor demand that is greater than the decline in labor supply. Again, this would lead to a reduction in employment— no surprise— but it would also correspond to downward pressure on wages from an excess supply of labor, as well as declines in vacancies and quit rates. Workers would report that job availability is falling and firms would be saying that hiring is getting easier. So which of these two situations are the data telling me we are in? It's clear to me that the data are saying that there has been a greater reduction in demand than supply. I'm not seeing or hearing stories of an acceleration in wage growth, an increase in job openings, or a rise in the quits rate. The overwhelming share of the data I've cited so far tonight supports the weak demand story. There's definitely a reduction in supply, but to me that is masking the extent of the reduction in demand, and that's what I'm concerned about. When outcomes are uncertain, policymakers must manage the risk. And the evidence is pointing toward a greater risk that low job creation is predominantly demand-driven. And this has implications for monetary policy. So let's talk about the implications of this hard and soft data. With underlying inflation close to the FOMC's target and evidence of a weak labor market, I support cutting the Committee's policy rate by another 25 basis points at our December meeting. For reasons I have explained, I am not worried about inflation accelerating or inflation expectations rising significantly. My focus is on the labor market, and after months of weakening, it is unlikely that the September jobs report later this week or any other data that comes out in the next few weeks will change my view that another cut is in order. I worry that restrictive monetary policy is weighing on the economy, especially how it is affecting lower- and middle-income households. A December cut will provide additional insurance against an acceleration in the weakening of the labor market and move policy toward a more neutral setting. Thank you very much. And I understand there's Q&A.

Yeah, so I'd say the data that would have to come in is likely to show continued labor demand weakness, slowing economic growth, declining or slowing consumer spending. This is all just standard stuff for demand-side issues that monetary policy can deal with. So that's what you would have to see in the coming months. If you suddenly saw a big rebound in the job market, a big rebound in economic growth, okay, then the economy is doing okay and there's less of a need to provide insurance cuts in particular. So that would be it. We have standard things we would always look at. On the size of our balance sheet— it's amazing, most people don't want to talk about a balance sheet, but a room full of economists— so I would say our balance sheet is roughly where it is right now, pretty much right spot on. We're starting to see market signals in terms of interest rates that are starting to creep up in short-term funding markets. That's starting to tell you that reserves are getting towards that scarce point. We don't really want to get there, but we're getting kind of close. I'll give you an example. Back in July of 2022, I was asked what would be the size of reserves when we stopped quantitative tightening (QT), and I said I'm guessing about 9% of GDP. I got so much grief for saying that. We'll stop on December 1st, and when we stop, the ratio is going to be 9.3%. Not too bad for saying it three years ago. So I think we're basically where we are in terms of the right size balance sheet, and I think some of my colleagues have said it probably won't be long before we actually have to start—

Letting the organic growth in the balance sheet start. So I don't perceive us staying where we're at for a real long time because just natural reserve demand, currency demand, everything else will start pushing it back up.

No, I don't think so. It's a question of how long did you want to stay with your balance sheet totally constant? The closer you get to like what we would call ample instead of abundant, those are two phrases that seem like they're the same, but clearly they're not. If you get close to ample, then you're going to stay at that fixed level for a much shorter period of time. So really a decision is how close did you want to get to ample when you're abundant and then wait before organic growth took off. So I don't think there's any mistake about it at all. It's just a question of how much time you want to wait before the balance sheet starts growing. I'm guessing it could be as short as a month, could be a couple of months. But I don't think there was any reason we should have stopped and let it sit there for a year, year and a half, which is all you would have done if you'd have stopped a lot earlier.

Yeah, I would say the one thing on the soft data that I've been hearing more and more and talking to a lot of people particularly CEOs of companies is four to six weeks ago we were still in this kind of no hire no fire mode. They're starting to talk about layoffs, they're starting to plan for them in the future and it could be AI related, it could be a lot of other things, but it's now that's the thing I'm starting to hear. It's not just going to be no hire no fire, that at some point this is going to start happening. So that would be the one thing on the anecdotal side that I've heard a lot more of in the last four weeks. And that's what's got me more concerned. We should be paying more attention to the labor market than we should because we're maybe four tenths of a point over our target on inflation.

Not going to touch that one.

Next.

Well, when I again, I can't stress enough the value as an academic economist my whole life looking at hard data and running regressions and all the models we do. Getting out and actually talking to people who do this is really valuable. I can't tell you how invaluable it has been for me. So when I talk to people and ask, you get a couple of things. So early on I would say it was a lot of tariff uncertainty, trade uncertainty, nobody really knowing. It didn't mean they were going to not hire but they were certainly pausing until they saw. I also heard that the firms were eating a lot of the tariffs, they weren't passing it on. And one way they were eating that tariff was cutting labor cost. That's a big number for most firms. It's an easy way to generate revenue without doing some other things. Now, I'm hearing the same story on AI. How are firms going to pay for all this AI investment? Well, they're just not going to hire and they may get rid of people. So, that would be another key factor. And then again, this point about you just go talk to firms that work with low and middle income households. They'll tell you point blank, they're just not coming in the door and then these firms are not going to be hiring. So, it's a combination of all these things. And so, the question is, by cutting the rates, can we at least on the margin do something? Well, that's what we try to do. I'm not going to say I'm going to cause with a 25 basis point cut for job growth to go back to 150,000 a month or whatever it is. But that's typically what I hear when I ask firms, why aren't you hiring or why are you going to let people go?

So I mean and I used to argue that well you go read speeches and everything else you kind of get the sense that there is disagreement but we have to make a decision every six weeks. We don't get to kick the can down the road. That means you have to compromise on your positions at times right and that if you believe that a consensus that it's better to send a 12 nothing or 11 to 1 vote than seven to five then you're going to sort of say look we got to compromise and get to this point. So that's long been the case. Now, on the group think thing, people who are accusing of this, get ready. You might see the least group think you've seen from the FOMC in a long time. That's apparently a good thing from this crowd. So, I don't find myself personally to sense that problematic. It doesn't mean anything about the chair's leadership or disagreements. That's the whole point of having a committee is to have different points of view. The only problem is if it gets really down to 7 to five for us, then one person switches the next meeting and the whole trajectory changes. And that's kind of the danger with these kind of razor thin one vote things. It doesn't give people confidence what the next vote will necessarily be.

Yeah, I mean if you just look at our survey of economic projections which is the long run neutral rate here's like about a 200 basis point gap. What neutral is is in the eye of the beholder. I mean it's not really clear that there's any kind of consensus on what it would be. I have colleagues that I think have made comments that said, 'Look, we're not very far from neutral right now.' And others say, 'We're still quite a ways away.' And that's kind of where some of the disagreement comes in on the committee. People point to the financial markets and say, 'How can you say we're restrictive? Look at this stock market. Look at these bond markets.' Yeah. Okay. It's loose for corporate America. When I go talk to households, when I go see medium-sized households, they can't get a house. They can't afford to buy a car anymore. This doesn't tell me financial conditions are loose for the American households. So that's this kind of they keep saying this kind of K-shaped economy that yeah, if you're in the top income groups, there's nothing loose. But if you're below the top, say 60% of the income distribution, things are just not that great.

Where are you? Here you are.

Well, I'm going to stick to the Fed company line on this one. We don't talk about fiscal policy. Now, I have made comments in the past and Chair Powell and others have made that if you're running a 6% deficit to GDP and a 3% primary surplus, that's not sustainable in the long run. Does it mean we're in a state of fiscal crisis in the next five years? Probably not. We don't know what the long run means. And I've heard some British economists said, 'We're all dead anyway, so it doesn't matter.' So, you know, and I've seen some recent academic research that says, look, you can go a lot higher than we think you can in terms of debt to GDP. I mean, Japan's always the mystery at 200 roughly 250%. And the answer is, yeah, but that's Japan. I'm really tired of this answer for 25 years that's just Japan. They're different. Why, you know, why is it? So, maybe there is a lot more that we've kind of forget about what we think is fiscal discipline, at least in some near-term period of time. So, I'm not going to sort of talk about what could happen in the next five years. I don't think necessarily any big crisis is going to occur. You'd start seeing it in yields, term premium, things like that. Low demand at auctions. I mean, there would be signals that tell you there's starting to be some problems with it, but we haven't seen anything like that in the US.