The Philadelphia Fed President, Anna Paulson, who will have a vote on the Federal Open Market Committee (FOMC) in 2026, stated on Tuesday that she remains open to the future path of interest rates, with future policy adjustments hinging primarily on core inflation trends. If underlying inflation remains persistently high, the Federal Reserve may need to tighten monetary policy further to ensure inflation returns to the 2% target.
In a recently published article, Paulson noted that there are currently two plausible scenarios explaining the current effect of monetary policy on inflation, and upcoming economic data will help the Fed determine which scenario is in play and whether policy adjustments are needed. She pointed out that the first scenario is if future inflation data continues to improve and long-term market inflation expectations remain stable, this would indicate that current interest rate policy is still "mildly restrictive," sufficient to bring inflation back to the Fed's 2% target within an acceptable timeframe.
However, she also noted that underlying inflation has only "moderately declined" over the past year, which could also imply that current interest rates are "still not restrictive enough." Paulson stated, "If underlying inflation remains stubbornly high, the lack of further improvement over time would itself signal the need for a more restrictive monetary policy."
The Federal Reserve last week held the federal funds rate target range steady at 3.50%-3.75% for the fifth consecutive time. Three officials voted in favor of a 25-basis-point rate hike, arguing that moderate tightening sooner could reduce the risk of having to take more aggressive measures later. Paulson noted that voting to hold rates steady last week "was not a difficult decision" for her. In an interview, she said current evidence still suggests monetary policy is "mildly restrictive," but continued improvement in underlying inflation is needed. She stated, "If we don't see that progress, we must remain open to recalibrating monetary policy. Our goal remains to bring inflation back to 2%."
Regarding recent economic data, Paulson believes the improvement in a series of inflation indicators is encouraging but still insufficient to change the policy assessment. Data shows that the Fed's preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index, fell 0.1% month-over-month in June, while the core measure, excluding food and energy, also rose less than expected. Meanwhile, inflation-adjusted consumer spending rose 0.4% month-over-month, the fastest pace since July last year. Paulson said, "The recent improvement in some inflation data is a step in the right direction, but it's just one step." She estimates that the current underlying inflation rate in the U.S. is between 2.4% and 2.8%. She emphasized that persistently above-target underlying inflation is the indicator she is most focused on when assessing policy.
Paulson also indicated that the U.S. labor market remains broadly stable, but escalating tensions in the Middle East have increased economic uncertainty and pushed up some inflationary pressures. Additionally, the boom in artificial intelligence (AI) infrastructure construction has created upward price pressure in some areas but has also boosted economic growth.
When asked about recent reform proposals from Fed Chair Kevin Warsh, including establishing multiple working groups to study policy communication and balance sheet management, and potentially changing the current eight annual meetings to six rate-setting meetings plus two economic seminars, Paulson expressed an open mind. She said, "Re-examining how we work is a good thing. Just like with monetary policy, I am open to learning more about the pros and cons of holding six or eight policy meetings a year and the potential impact of different arrangements."
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