The economy keeps surprising to the upside. We got third quarter GDP of 2.8%, driven by strong consumer spending up 3.7%. We've seen household incomes and savings revised upwards. Can the strength continue into next year? I think so. I mean, that's you in your question, you said it correctly. We continue to be surprised by the resilience of the US economy. Three or four years ago, if you'd said to me we're going to raise interest rates by 500 plus basis points, I would have thought that would slam the brakes on the US economy. It hasn't. The economy's been remarkably resilient, which is a really good thing. So in the last couple of years, we brought inflation down, not all the way to 2%. We're running at about a 2.5% rate, and the labor market has remained strong. Right now, it looks like that's going to continue. I do a lot of outreach to businesses large and small across my part of the country, to labor groups. They all share cautious optimism. And so right now, the fundamentals seem strong, and I'm optimistic that's going to continue.
How do President-elect Donald Trump's proposed policies, from across-the-board tariffs to mass deportations, tax cuts, and deregulation, influence your outlook for the economy, understanding that we don't quite know the exact timing and extent of the implementation of these policies?
Well, there's so much uncertainty about what any new administration is going to do, ultimately what they're going to do in negotiating with Congress. We at the Fed simply have to wait and see. Whatever the Congress and the executive branch decide to do, we will then model it into our analysis of the economy, analysis of the economy's potential, and outlook for the labor market and inflation. But until those policies are decided upon, until they become clear, we can't do anything. And so we're just going to wait and see.
On the proposed tariffs, we know that the president-elect has said that he's looking to impose 10% tariffs on all US imports, 60% tariffs on all Chinese imports. If that scenario were to go into effect, what impact would you expect on inflation and supply chains?
Well, on inflation, just step back from those specific proposals and just think about how tariffs work. A tariff, generally speaking, from an inflation perspective, we think of as a one-time increase in prices. So if you have a 1% tariff, you could think of it as a 1% increase in prices of those goods that are subjected to the tariff. That by itself is not inflationary over the long run; it's a one-time change in the price level. Where it becomes complicated is how the other country responds. So if there's a tit-for-tat, an increase in tariffs from the US, a response from other countries, and it goes back and forth, then you could imagine a longer-term inflationary impact. And so right now, as I said a moment ago, it's uncertain what the proposal will be, what will get implemented, and then importantly, how other countries will respond. Right now, we're all just guessing, and so I can't opine one way or the other.
Sure. When it comes to immigration, that has been a big part of the resiliency of the job market the past couple of years. It certainly helped with the labor shortages that we've been seeing. The president-elect has proposed mass deportations. Again, we don't know the extent of this policy, but taken on its face, generally speaking, what impact would you expect on the job market and wages?
Well, if you just start by assuming that the vast majority of immigrants who are here are gainfully employed, then at the extreme, those businesses would lose those workers, and that would provide some form of disruption to those businesses. I ultimately think what'll end up getting implemented will be a negotiation between Congress, the executive branch, and business. They'll figure out a way to do whatever they've decided to do, and then we will have to respond. And so I'm not here to opine positive or negative, but ultimately it could have a big effect. But we need to wait and see on what ends up actually happening.
Let me ask you about your outlook for inflation. You said earlier this fall that you weren't too worried about upside risks to inflation. You cited wages and core non-housing services prices that continue to fall. But core PCE, your favorite inflation gauge, has been stuck at 2.7% for three months. So how confident are you that inflation is still falling to your 2% target?
Well, we break inflation down by its subcomponents. So goods inflation is running roughly back where it was pre-pandemic to slightly disinflationary levels. If you look at other parts of services inflation, they're tied to wages. Wage growth is slowly cooling. Housing inflation is the big elephant that is still out there. And if you look at where new leases are, new lease inflation has already fallen back down to very low levels. But new leases take a couple of years to work their way through into the broader measures of housing inflation. So, you know, I don't want to declare victory too early, but I think there's pretty good reason that we have confidence that the housing piece of this will slowly return back down to more normal levels. Ultimately, we're going to get back down to 2% inflation. It may take a year or two to get all the way there given some of these housing dynamics, but the trends so far are encouraging.
What about the job market? We've seen a lot of volatility in those monthly jobs reports. The October report slammed by those two hurricanes, the Boeing worker strike. How are you looking at the labor market now?
Well, the labor market, as we mentioned a few minutes ago, has been surprisingly resilient. A 4.1% unemployment rate, it's a good labor market. When I meet with, again, not just businesses but also labor groups around my region, it's one of cautious optimism. I mean, a bunch of labor unions that I've met with recently have said that they're feeling confident enough that they're going to have some actions taking place, meaning they're preparing to strike. They're feeling like they're in a strong position. Usually, I don't hear labor unions talking about that if they're feeling like the pendulum has swung away from labor. So most of the dimensions that we look at, the labor market is still strong. It is not as red hot as it was a year or two ago, but the fundamentals are still sound. And so that's encouraging to me, that the labor market looks robust and consumer spending continues to surprise. Consumers continue to be resilient. The fact that the savings rate has been revised up is also encouraging, suggesting that consumers on average are not getting overextended. So right now, the economy looks like it's in a strong position.
So then what does that mean for the rate-cutting path forward? You said earlier this week that another rate cut in December is certainly possible. What would make a rate cut not possible in December?
Well, I think if we saw inflation surprises to the upside between now and then, you know, that might give us pause. If the labor market... it'd be hard to imagine the labor market really heats up between now and December; there's just not that much time. I think there'd have to be a surprise on the inflation front for it to change the outlook so dramatically. The bigger question long-run is where are we going to settle? What does neutral represent? One big surprise over the past couple of years, if the economy has been more resilient than I expected in the face of this high policy rate, how do you answer that question? Why has that been the case? The answer that I'm taking away is maybe the neutral environment, the neutral rate environment, has gone up, at least in the short run. Now, how long is that higher neutral rate environment going to persist? I don't know. A helpful data point over the last couple of years is productivity looks like it's been stronger. If productivity is going to continue to be strong, all else being equal, that would relate to me to be a higher neutral environment. Think about what sets the neutral environment: it's the balance between savings and investment. And if the productivity environment of the US economy is higher, all else being equal, there should be more demand for investment capital to fund those productive investments. So in a higher productivity environment, the neutral rate ought to be higher. And so if we are in a structurally higher productivity environment, that would tell me we have less room to cut until we eventually get back to neutral. I'm not saying we're very close to neutral right now, but when we think about the destination, we may not go down as far.
So given what you just said, we know the consensus of the FOMC is for four more rate cuts next year. Given the strength of the economy that you expect it can continue, given your comments just now on neutral, do you see fewer than four rate cuts next year?
We have to see what the data says. I mean, ultimately, the data... you know, one thing that Chairman Powell says is the neutral rate is not directly observable. We know it by its effect on the economy. And so we're going to continue to monitor the labor market, inflation, GDP, spending to try to figure it out. How close are we coming to neutral? I think we all agree we are above neutral now, but over the course of the next year, we're going to get a lot more information about where neutral is. And we're also going to be looking at market signals in terms of the real yield curve. Where is the long end of the real yield curve? That's giving us some feedback as well.
Let's get to the yield curve in a minute, but I'm curious whether Donald Trump's election changes the terminal rate forecast for you.
You know, we have to wait and see. We have to wait and see what ultimately gets enacted by the Congress and by the executive branch before we determine anything. Obviously, the long end of the yield curve has moved a lot since we started cutting rates, you know, six, eight weeks ago. The long end of the curve has moved a lot. It doesn't look like that is in long-term inflation expectations. There's been some move in short-run inflation expectations, but long-run inflation expectations do appear to be well anchored. Could that be a view that productivity is higher and the neutral rate is higher? That's probably part of it. Some people have speculated that maybe there's expectations about more deficits to come. You know, we'll have to see. There are a bunch of different components in there that we need to try to strip out to understand what markets are telling us. And the thing that gets complicated for us is that we look at markets, but a lot of times markets are looking at us. So it's a little bit like we're looking in the mirror. So trying to figure out what is a real signal and what is just a reflective signal, it's an inexact science.
How restrictive do you think you are right now?
I would say, in my judgment, I think we're modestly restrictive. Just by virtue of the fact that we went up to 5.25% and the job market remained as resilient, that tells me we could not have been very, very restrictive. So instead of, while I thought we were putting two feet on the brakes, I think in hindsight we were probably only putting one foot on the brakes. And what's really difficult about this is this notion of a neutral rate. It appears to be time-varying. So yes, the neutral rate has been elevated in recent months or the last couple of years. How long is it going to stay there? You know, we're not sure.
