Fed policy, inflation, and Middle East conflict (with Michael McKee)

The market is pricing equal probabilities of a cut versus a hike, with the most likely outcome being rates held steady.

Michael McKee

Mary Daly

The real signal from the last FOMC meeting is that everyone agreed to hold rates steady and that 'higher for longer' was already priced in by markets.

The labor market has stabilized and is not creating inflationary pressures. Businesses are cautiously optimistic.

The New York Fed survey shows inflation expectations rising to 3.6% for the next year. Is there a danger of them becoming unanchored?

Michael McKee

Mary Daly

Short-term inflation expectations reflect current gas pump and grocery store prices, not a drift of the anchor. Medium-term expectations have not moved.

Businesses are not broadly passing through price increases to consumers. Surcharges on energy are emerging, but not a broad pass-through. Wage inflation is consistent with 2% target.

Tariffs are still in place and more are coming. How are companies dealing with this?

Michael McKee

Mary Daly

Companies are splitting the tariff burden between margins, other producers, and consumers. They see these as one-time price adjustments that are rolling off. The new information is the oil price shock on top of already elevated inflation.

The Fed must balance overreacting vs. underreacting. Patience is key to see how the oil shock propagates.

Chairman Powell is concerned that after multiple supply-side shocks, consumers may no longer see 2% as normal.

Michael McKee

Mary Daly

This is a valid concern and a focus of research. However, I do not see evidence in the data that longer or medium-run inflation expectations have drifted from the 2% anchor.

Wage inflation is consistent with 2%. We cannot jump to the conclusion that it might be true and therefore it is true.

Kevin Warsh has suggested a smaller balance sheet. What are your thoughts on scarce vs. ample reserves?

Michael McKee

Mary Daly

Providing liquidity is important to avoid a repeat of the financial crisis. There are many ways to provide liquidity without a large balance sheet footprint. This is a good topic for study, including communication aspects.

The ECB uses 'ample on demand' while the Fed uses 'ample on supply'. Both approaches have merits.

Would you get rid of the SEP and dot plot in favor of scenarios?

Michael McKee

Mary Daly

Scenarios are helpful in times of high uncertainty because they communicate the Fed's reaction function rather than false precision. I look forward to deliberations on communication reforms.

Point estimates about what will happen in 1-6 months are less interesting than how the Fed would react to different economic situations.

Kevin Warsh has suggested Fed officials talk too much. Would you cut back on communication?

Michael McKee

Mary Daly

The purpose of communication is to explain the Fed's reaction function and why policy choices are made for the American people. I look forward to debates with Kevin Warsh on these topics.

Where we are going next week is less relevant than how we would react to economic situations.

Michael McKee

Kevin Warsh says the Fed talks too much. Would you cut back on communication?

Mary Daly

We communicate to explain our reaction function to the American people. Point estimates of where we will go next are less relevant than how we would react to economic situations.

Michael McKee

Kevin Warsh has suggested you all talk too much. Would you be willing to cut back on communication?

Mary Daly

We need to ask ourselves why we communicate. We are trying to explain our reaction function and why policy choices are for the American people. Where we are going next week is less relevant than how we would react to economic situations. I look forward to having Kevin Warsh join the FOMC and to the debates.

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