Musalem Urges Fed to Be Cautious as Rates Approach Neutral

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00:00The economy has been pretty resilient. If you look at the first three quarters of this year,

00:03in spite of the uncertainties, it's grown at about 1.8 percent, which is the long-term growth

00:07rate of the economy. The fourth quarter is going to be probably weak because of the shutdown,

00:12but then there's going to be a rebound in the first quarter. We have some tailwinds into next

00:16year, so I think next year the economy is going to grow at or above potential. We have some fiscal

00:22stimulus in the pipeline from the One Big Beautiful Bill or the OB-3. We have 150 basis

00:28points of easing by the Federal Reserve over the last year. That's still working itself

00:32through the pipeline. We have very accommodative financial conditions, accommodative of economic

00:38activity, and we have some deregulation in the pipeline, and banks are beginning to exercise

00:46that by lending. I think there are some tailwinds, and that's my outlook for the economy. For the

00:53labor market, I think the labor market will continue to soften some, but it's going to do

00:58that in an orderly manner, and it's going to stay around full employment, which is unemployment

01:02rate around 4.5, let's say. It's possible in the fourth quarter, because of the shutdown,

01:07the unemployment rate may tick up more than usual, but I expect that to then stabilize.

01:12And for inflation, we have inflation running at 3 percent, which is a full percentage point

01:16above our target. We have had now inflation running above our target for five years. Part of the

01:24inflation that we have today is due to tariffs, only about three-tenths in our team's estimation.

01:30I expect the impact of tariffs to fade over the next two to three quarters. So by the second half

01:35of next year, I expect the tariffs to begin to fade and inflation to begin to come back down towards

01:412 percent, provided that we maintain appropriate monetary policy. So that's my outlook for the

01:45economy. That's the expectation. Of course, I could be wrong, and it's important to be humble in this

01:51job and understand that you could be wrong. And so there are risks to the labor market that could

01:56be weaker than I currently expect. There are risks on the inflation side where inflation could be more

02:01persistent than I currently expect. And weighing all of that, weighing the outlook and the balance of

02:08risks, I supported the last rate reduction, and I've supported the last 150 basis points of rate

02:16reductions starting in September of last year, precisely to protect the labor market so that it

02:23can remain around full employment. Going forward, I think we need to proceed and tread with caution

02:31because I think there's limited room for further easing without monetary policy becoming overly

02:38accommodative. Remember, inflation is still at 3 percent. And I believe policy right now is somewhere

02:44between modestly restrictive and neutral. It's probably getting closer to neutral than to

02:49modestly restrictive. One way to think about that is if you look at the real interest rate, that is

02:54the federal funds rate that we control, and you subtract inflation from it. So the nominal rate,

03:01which we control, is about 3.8. Inflation is running at about a little less than 3. Subtract one from

03:07the other, and you get that the real interest rate is running at around 1 percent. 1 percent happens to be

03:13the real interest rate that the average or the median of the committee believes is the long-term

03:21neutral rate of the economy. So I believe we need to continue to lean against above-target inflation while

03:29providing some support to the labor market.