Remarks on the Economic Outlook and Alternative Scenarios

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Feb. 20, 2025

St. Louis Fed President Alberto Musalem spoke at an Economic Club of New York event in New York City. He gave the talk “Remarks on the Economic Outlook and Alternative Scenarios” and participated in a moderated Q&A.

Full Text of Prepared Remarks

The text is as prepared for delivery.

Good afternoon. It’s a great pleasure to return to the Economic Club of New York and reconnect with many good friends and former colleagues. I am also looking forward to an engaging discussion with Abby Joseph Cohen.

I will first offer some remarks about how I perceive economic and financial conditions, the outlook, and some plausible alternative scenarios with monetary policy implications. Let me stress that these are my personal views and not necessarily those of my FOMC colleagues. I know the importance of getting to the point in New York, so let me do that. In my view, the economy and monetary policy are in a good place. I believe patience will help us as we seek maximum employment and price stability for the American people. Doing that work must be our focus at all times.

Last month, the FOMC voted to leave its target range for the federal funds rate unchanged at 4.25%-4.50%. I supported that decision because economic growth is robust, the labor market is solid, financial conditions are supportive of growth, and inflation remains above target. The U.S. economy is strong, with both the level and growth rate of GDP at or above long-run potential. Labor market conditions remain solid—with the unemployment rate at or below estimates of its natural rate. Inflation has fallen considerably from its peak, and there has been little or no cost in terms of forgone employment or economic activity. However, inflation is still above 2%, and some measures of inflation expectations have recently risen. After 100 basis points of interest rate cuts in the fall, I judge that monetary policy is modestly restrictive, and meaningfully less restrictive than it was six months ago.

I believe it is appropriate to monitor economic conditions and the outlook before making any further adjustments to the stance of policy. Monetary policy is well positioned to address risks to both sides of the Fed’s dual mandate. If the economy remains strong and inflation remains above target, then I believe that modestly restrictive policy will remain appropriate until there is confidence that inflation is converging to the FOMC’s 2% target. If labor market conditions were to deteriorate while inflation expectations remain anchored at a level consistent with 2% inflation, I believe policy could be eased further. I will say more about this later.

Current Conditions and Outlook

The U.S. economy entered 2025 on a very solid footing with healthy forward momentum.The St. Louis Fed’s dashboard Economy at a Glance, which is powered by FRED, the St. Louis Fed’s signature database, provides a high-level overview of current U.S. economic conditions. Consumers continued to power growth. Personal consumption expenditures grew at a robust 4.2% rate in the fourth quarter—the highest of any quarter in 2024—while real final sales to domestic purchasers grew at a healthy 3.1% annual rate.

The prospects for continued solid growth look good. The balance sheets of firms and households are generally in good shape. Financial conditions are supportive of economic activity, especially for borrowers who directly access capital markets for funding. Surveys indicate that business confidence has risen in the last three months and that planned capital expenditures have increased.Surveys of business confidence include the National Federation of Independent Business (NFIB) January 2025 Small Business Optimism Index, with results reported in a Feb. 11, 2025, article, “Small Businesses Remain Optimistic, But Uncertainty Rising on Main Street,” and the Jan. 24, 2025, S&P Global Flash US PMI. Surveys reporting capital expenditure intentions include the NFIB Small Business Economic Trends report, surveys by the Federal Reserve banks of Dallas, Kansas City, Philadelphia and Richmond, and the Federal Reserve Bank of New York’s Business Leaders and Empire State Manufacturing surveys.

However, measures of economic policy uncertainty are higher than average, and this could weigh on the spending plans of businesses and consumers.For a widely followed measure of economic policy uncertainty, see the US Monthly Economic Policy Uncertainty Index. Recent surveys suggest consumers are becoming somewhat less confident, and January retail sales suggest they might be more cautious.See, for example, January and early February surveys from The Conference Board and the University of Michigan. But December sales were strong, and I’m not overly concerned by a single month of data.

Labor market conditions remain solid, and I see risks to employment as roughly balanced. After softening through the first three quarters of 2024, the labor market has stabilized and has recently shown some signs of strengthening. Payroll growth averaged 237,000 over the past three months—exceeding the break-even pace—and the unemployment rate ticked down to 4%.The Bureau of Labor Statistics reported in the January 2025 Employment Situation report that adverse weather conditions and wildfires had no discernible impact on employment in January. However, researchers at the Federal Reserve Bank of San Francisco estimated that adverse weather conditions reduced January payroll growth by some 84,000 jobs, as shown on the Weather-Adjusted Employment Change data page. Job openings and quits rates have declined but layoffs have remained low. A recent National Federation of Independent Business survey found a sizable net percentage of small businesses are expecting to add jobs in the coming three months.See the NFIB report cited in Footnote 2. Recent surveys conducted by several Federal Reserve banks also show increases in the percentage of firms planning to add jobs in the months ahead.Summary based on surveys conducted by the Federal Reserve Bank of Chicago and by the Federal Reserve banks of Dallas, Kansas City, New York, Philadelphia and Richmond linked in Footnote 2.

While growth in average hourly earnings and other measures of employment costs have remained firm, the labor market does not currently appear to be a significant source of inflationary pressures because productivity has also risen. I will continue to monitor the balance between compensation growth, productivity growth and inflation going forward.

Inflation has retreated substantially from its peak in mid-2022 but remains above the FOMC’s 2% target. The January CPI report showed large monthly increases in goods, services and shelter prices, and for core as well as headline inflation. Based on the CPI and PPI reports, the core and headline PCE price indexes are estimated to have increased by around 0.3% in January. If so, that would imply a core inflation rate of 2.6% and a headline rate of 2.4% on a 12-month basis. Residual seasonality has been suggested as a contributing factor, at least for the CPI. But, taken at face value, the reports show that more work is required to achieve price stability.

Alternative Scenarios and Monetary Policy

Looking ahead, I expect inflation will continue to converge to the FOMC’s 2% target and the labor market will remain near full employment. This baseline scenario requires that monetary policy remains modestly restrictive until inflation convergence is assured, at which point the policy rate can be gradually reduced toward the neutral level as convergence progresses. Critically, the scenario requires that inflation expectations stay well anchored. Various changes in trade, immigration, regulatory, fiscal and energy policies, or other changes in the economic environment, could materially affect the path of the economy. My baseline scenario assumes the net effect on inflation and employment of all such policy changes will be small in the near to medium term.

Around this baseline scenario, the risks of inflation stalling above 2% or moving higher seem skewed to the upside. A January survey by the National Association for Business Economics found a higher percentage of firms expecting increased materials costs, and a higher percentage that have plans to raise their prices in coming months.In the January National Association for Business Economics (NABE) Business Conditions Survey, 35% of firms indicated that they expect to raise prices charged in the next three months, compared with 28% in the October survey and 35% in the July survey. A relatively modest 30% of respondents reported that prices charged by their firms had risen in the past three months. Federal Reserve bank surveys also show evidence that firms expect to raise their prices over the next six to 12 months.See Footnotes 2 and 7 for Reserve bank surveys.

Market and some survey measures indicate that near-term expectations of inflation have risen notably over the past three months, while the University of Michigan survey shows some firming of longer-term consumer inflation expectations.See Footnote 4 for the University of Michigan survey link. Business and professional surveys, such as the Blue Chip survey and a survey produced by the Federal Reserve Bank of Atlanta, have shown only modest increases in near-term inflation expectations. I will be monitoring these developments closely for signs that short-term expectations of higher inflation could be feeding into medium- to longer-term inflation expectations.

An alternative and plausible scenario in which inflation ceases to converge, or rises, at the same time the labor market weakens must also be considered. This scenario could arise for a variety of reasons. These days, higher tariffs and immigration policies are often discussed and thought likely to increase prices, cool aggregate demand and possibly soften employment. From the standpoint of monetary policy, it could be appropriate to ignore, or “look through,” an increase in the price level if the impact on inflation is expected to be brief and limited. However, a different monetary policy response could be appropriate if higher inflation is sustained, or longer-term inflation expectations rise. In that scenario, a more restrictive path of monetary policy relative to the baseline path might be appropriate.

In the current environment, the stakes are higher than they would be if inflation was at or below target. With robust growth, a solid labor market, supportive financial conditions, underlying inflation above 2%, and some measures of inflation expectations recently rising, the risk that inflation expectations could become unanchored is higher than it would be if the economy was operating with slack and if consumers and businesses had not recently experienced a period of high inflation.

Implied in the FOMC’s Statement on Longer-Run Goals and Monetary Policy Strategy is a balanced approach that takes into account the extent and timing of both employment shortfalls and deviations of inflation from target when the Committee’s maximum employment and price stability goals are in conflict. A balanced approach is feasible if longer-term inflation expectations remain well anchored. Controlling inflation is less costly, and the scope for responding effectively to variations in output and employment is greater, when inflation expectations are tightly anchored.

In other words, anchored inflation expectations make a balanced approach feasible for addressing conflicting goals. In a scenario in which the FOMC’s dual mandate objectives are seemingly in conflict, I would look closely for assurance that medium- to longer-term inflation expectations are remaining well anchored, and I would be especially concerned by evidence suggesting they are becoming unanchored. That is why I put a high priority on making sure inflation continues to converge to the FOMC’s 2% target in the current environment of full employment and strong growth.

Conclusion

To reiterate, I expect inflation will return to 2% over time and the labor market will remain strong. At the same time, I perceive the risk that progress on inflation could stall as being greater than the risk of substantial labor market weakening. And, while not my baseline, there are scenarios where the FOMC could face conflicting dual mandate goals.

At present, the economy and monetary policy are in a good place. A patient approach will help achieve the goals of maximum employment and price stability, and support a durable economic expansion for the American people.

Thank you.

Notes

  1. The St. Louis Fed’s dashboard Economy at a Glance, which is powered by FRED, the St. Louis Fed’s signature database, provides a high-level overview of current U.S. economic conditions.
  2. Surveys of business confidence include the National Federation of Independent Business (NFIB) January 2025 Small Business Optimism Index, with results reported in a Feb. 11, 2025, article, “Small Businesses Remain Optimistic, But Uncertainty Rising on Main Street,” and the Jan. 24, 2025, S&P Global Flash US PMI. Surveys reporting capital expenditure intentions include the NFIB Small Business Economic Trends report, surveys by the Federal Reserve banks of Dallas, Kansas City, Philadelphia and Richmond, and the Federal Reserve Bank of New York’s Business Leaders and Empire State Manufacturing surveys.
  3. For a widely followed measure of economic policy uncertainty, see the US Monthly Economic Policy Uncertainty Index.
  4. See, for example, January and early February surveys from The Conference Board and the University of Michigan.
  5. The Bureau of Labor Statistics reported in the January 2025 Employment Situation report that adverse weather conditions and wildfires had no discernible impact on employment in January. However, researchers at the Federal Reserve Bank of San Francisco estimated that adverse weather conditions reduced January payroll growth by some 84,000 jobs, as shown on the Weather-Adjusted Employment Change data page.
  6. See the NFIB report cited in Footnote 2.
  7. Summary based on surveys conducted by the Federal Reserve Bank of Chicago and by the Federal Reserve banks of Dallas, Kansas City, New York, Philadelphia and Richmond linked in Footnote 2.
  8. In the January National Association for Business Economics (NABE) Business Conditions Survey, 35% of firms indicated that they expect to raise prices charged in the next three months, compared with 28% in the October survey and 35% in the July survey. A relatively modest 30% of respondents reported that prices charged by their firms had risen in the past three months.
  9. See Footnotes 2 and 7 for Reserve bank surveys.
  10. See Footnote 4 for the University of Michigan survey link. Business and professional surveys, such as the Blue Chip survey and a survey produced by the Federal Reserve Bank of Atlanta, have shown only modest increases in near-term inflation expectations.