Fed Adjusts Approach as Job Growth Cools and Inflation Outlook Remains Unclear

At the 2025 Jackson Hole Economic Symposium, Federal Reserve Chair Jerome Powell discussed how the U.S. central bank is rethinking its monetary policy strategy and preparing to alter interest rates as economic conditions change. The Fed is currently balancing two major concerns: increasing risks to the job market and moderate upward pressures on inflation. Powell highlighted that as the dynamics between these risks shift, policy adjustments may be necessary. Although maintaining stable prices has long been the Fed’s primary objective, its recent focus shows a heightened awareness of labor market vulnerabilities, which have started to emerge.

Despite the U.S. labor market remaining close to full employment, there has been a notable decrease in job growth. Over the last three months, payrolls have grown by an average of just 35,000 per month, a stark drop from 168,000 per month throughout 2024. This reduction, along with a slight increase in the unemployment rate to 4.2 percent, points to a broader shift in both labor supply and demand, influenced by stricter immigration regulations and structural changes in the economy. Powell remarked that while the labor market is still relatively balanced, the slowdown in both supply and demand has created a “curious” scenario in which the risk of job losses is increasing. This has led to concerns that, if economic conditions worsen, layoffs and unemployment could rise quickly.

Inflation remains another significant issue. In July, core PCE prices were up 2.9 percent year over year, largely due to higher prices for goods and non-housing services. Powell pointed out that recent tariff hikes have contributed to increased consumer costs, but he believes these effects are likely to be temporary and should not trigger persistent inflation. The Fed is paying close attention to the interplay between wages and prices, since rising prices could prompt workers to ask for higher pay. However, with the labor market not especially tight and risks to employment on the rise, this scenario appears unlikely for now. Powell also stressed the need to keep inflation expectations anchored, noting that long-term expectations are still consistent with the Fed’s 2 percent objective.

In response to these shifting circumstances, the Fed has updated its monetary policy approach. This is the second review since 2020, and it aims to make sure the central bank’s tactics are effective under a wide range of economic scenarios. Notably, the Fed is moving away from the “flexible average inflation targeting” model introduced in 2020, which permitted inflation to temporarily surpass the target to compensate for previous periods of low inflation. The central bank found that this approach became obsolete after the sharp, unplanned inflation following the pandemic. The new framework stresses striking a balance between achieving maximum employment and stable prices, recognizing that these priorities may occasionally conflict.

The revisions also tackle communication issues linked to the earlier framework, especially regarding references to “shortfalls” in employment compared to maximum levels. The updated statements clarify that the Fed does not plan to disregard a tight labor market or avoid acting preemptively when necessary. Instead, the new language makes clear that employment can sometimes exceed real-time estimates of maximum employment without threatening price stability. This adjustment offers the Fed more flexibility to address varied economic conditions, while continuing to ensure openness and responsibility.

In the coming months, the Fed is expected to be cautious in making policy changes. Although there is no predetermined course, Powell signaled that evolving risks—particularly those related to the labor market—could prompt adjustments. This careful strategy underscores the Fed’s reliance on economic data, with any interest rate changes depending on ongoing reviews of key indicators. The next major policy meeting is set for mid-September, and investors are eagerly watching for hints about possible rate cuts.