Tom Barkin

Thank you for that kind introduction and for having me here. I will talk a bit about the state of the economy and then look forward to your questions. These are my thoughts alone and not necessarily those of anyone else in the Federal Reserve System.

Inflation: Still Too High

I want to start with inflation. While down from its peak, inflation remains too high. Our target is 2 percent, and that has served us well for a generation. But in April, 12-month headline PCE was 4.4 percent. Core was at 4.7 percent. We got the May CPI on Tuesday, and it showed 12-month headline at 4.0 percent and core at 5.3 percent.

If there is one thing we have relearned over the past two years, it is that everyone hates inflation. High inflation creates uncertainty. As prices rise unevenly, it becomes unclear when to spend, when to save or where to invest. Inflation is exhausting. It takes effort to shop around for better prices or to handle complaints from unhappy customers. And inflation feels unfair — the wage increase you earned feels arbitrarily taken away at the gas pump.

The Fed has moved aggressively against inflation, hiking rates 5 percentage points in the last 15 months. But inflation has proven stubbornly persistent. That’s true even if you exclude shelter inflation, whereby some accounts the data is lagging. I like to monitor monthly median PCE to look at the breadth of inflation. But it hasn’t come in at levels consistent with our 2 percent target in any month since spring of 2021. It’s hard to say we’re approaching our target when we haven’t yet hit it even for one month.

In part, I think inflation has persisted because the pandemic has remained with us — not the public health crisis, thankfully, but the economic dislocation it caused. Demand remains elevated, supported by ongoing fiscal outlays, nearly a trillion dollars in excess savings and tens of trillions more in added equity and housing wealth. At the same time, supply is still constrained by pandemic-era retirements and residual supply chain challenges in areas like autos, switchgears and machinery. The process of getting supply and demand back in balance has been slow.

It’s also clear that the inflation experience of the last few years has left its mark. Businesses have rediscovered the pricing lever. If they can raise prices and not lose much volume, they have an efficient path to increased earnings. They won’t throw that option away until competitors and customers force their hand.

So, the Fed is still working to bring inflation back to target.

A Plausible Story Bringing Inflation Down

Now I do see a story — a plausible story — for how inflation comes down. That story relies on weakening demand to control inflation.

Demand weakens because rate increases work with a lag. We started increasing rates 15 months ago, and many models estimate their impact starts to really hit around now. Demand weakens because credit conditions tighten. Following the bank turmoil earlier this year, banks preserve liquidity and protect earnings by stepping back from marginal lending.  And demand weakens because the pandemic economy continues to fade. Savings are spent down. Fiscal stimulus wanes. Consumption normalizes. As demand settles, that reduces its imbalance with supply and brings inflation back to target.

It’s a plausible story. But this isn’t our first campfire. We have all told ourselves a number of stories over the last two years. They each seemed compelling at the time, but inflation hasn’t yet seen a happy ending. At first, inflation seemed transitory, as fiscal stimulus faded and the economy fully reopened. Then supply chain remediation and lower commodity prices looked likely to feed through to prices. Then, when we raised rates and shrunk our balance sheet so aggressively last year, you might have thought inflation would have quickly come back in line. But inflation, while down, is still elevated.

So, I am still looking to be convinced, both that demand is settling and that any weakness is feeding through to inflation. That is particularly challenging because the data has been jumping around.

Let me take you through how I’m seeing that story develop.

I do believe demand is softening. You can see the impact of rate hikes in more interest-sensitive sectors like housing, manufacturing and business investment. Banks are feeling margin pressure and tell me they are absolutely stepping back from riskier sectors, newer customers and less profitable loans. That seems to have particularly hit small businesses and commercial real estate. And those who sell to lower-income segments tell me these consumers are cutting back and trading down, as pandemic era supports expire.

But consumer spending remains resilient. Think of it as weaker but not yet weak. Higher-income consumers are still spending, and higher wages are supporting consumption too. Over the last six months, the official data has bounced around, with two strong months and four weak ones. I take a lot of signal from credit and debit card data which shows year-over-year spending flattish since February.

That brings us to the labor market. Here, while secondary indicators like job openings and quit rates seem to be normalizing, we keep adding jobs month after month after month. 339,000 jobs were created in May — over three times the breakeven rate. Supply is getting a boost from increased prime-age participation and a bounce back in immigration. My corner sports bar has now reopened on Sundays and Mondays. Unemployment remains at a historically low 3.7 percent, and wage growth is still above pre-pandemic levels.

I’m increasingly wondering whether the pandemic era hasn’t made the labor market somewhat more resilient.  When you think of a slowdown, you naturally think of 2008 when manufacturing workers were sidelined across the Rust Belt and those last into the workforce bore a disproportionate burden. But those are the workers I hear are most in demand today, as manufacturing plants, hotels, construction sites and restaurants remain short of workers. Recent large company layoff announcements have targeted administrative functions, not front-line workers. These workers may have a lower propensity to file for unemployment, typically are unemployed for shorter periods, and often can leverage backup savings to bridge their consumption.

The question is whether inflation can settle while higher-income consumers are still spending, and the labor market remains this robust. We will learn a lot more over the next few months.

Policy: What Comes Next

As I said earlier, the Fed has raised rates aggressively. But, with forward-looking real rates now positive across the curve, we have been moderating the pace of those increases. Think of it as slowing your boat as you approach the dock. That gives us time to assess the data on demand and inflation and determine what more we might need to do.

I want to reiterate that 2 percent inflation is our target, and that I am still looking to be convinced of the plausible story that slowing demand returns inflation relatively quickly to that target. If coming data doesn’t support that story, I’m comfortable doing more. I recognize that creates the risk of a more significant slowdown, but the experience of the ’70s provides a clear lesson: If you back off inflation too soon, inflation comes back stronger, requiring the Fed to do even more, with even more damage. That’s not a risk I want to take.

So that’s my story. Let me open it up now for questions and input.