Speech by Governor Waller on the economic outlook

I am deeply grateful to Alvaro for the privilege of launching this new series of central banker lectures. 1 Let me start by saying a few things about the U. A. outlook for the economy and how it affects monetary policy. On this particular occasion, however, I felt it was appropriate to broaden my viewpoint and discuss what I believe to be the main issues facing OECD economies, issues that are especially significant to central bankers in our approach to monetary policy and other responsibility.

I still maintain my belief that the U. A. The state of the economy is stable. Eight of the previous nine quarters have seen real gross domestic product (GDP) growth above 2 percent, and the fourth quarter of 2024 is predicted to see growth above 2 percent as well. Despite this strong economic expansion, the labor market cooled in 2024, and employment is currently close to what I believe to be the FOMC’s (Federal Open Market Committee) maximum-employment goal. Nothing in the statistics or projections indicates that the labor market will significantly deteriorate in the upcoming months, in my opinion.

After a period of sharp deflation in 2022 and 2023, inflation seems to have stalled in the last few months of 2024. According to our most recent reading, the core inflation rate for personal consumption expenditures (PCE) for the 12 months ending in November is 2 points 8 percent. This represents a slight decrease from 3 to 2 percent a year ago. There have been calls to slow or stop lowering the policy rate as a result of this scant additional progress. Nonetheless, I think that over the medium run, inflation will keep moving closer to our 2 percent target and that more cuts will be necessary.

I’ll tell you why I think inflation will keep moving in the direction of our objective. First, progress has been uneven, as we witnessed when inflation briefly increased a year ago. However, if one smooths through the recent upticks, disinflation becomes more noticeable. I frequently use the six-month percentage change in core PCE prices, which is 2.4 percent at an annual rate for November and has primarily been declining toward 2 percent throughout the year, to extract the underlying trend in inflation. Second, after increasing by 0 points 26 percent in October, the monthly reading for November was significantly lower than anticipated at 0 points 11 percent. Third, increases in imputed prices—like housing and nonmarket services—which are estimated rather than directly observed and, in my opinion, a less accurate indicator of the supply and demand balance for all goods and services in the economy, have been a major contributor to inflation in 2024. About one-third of the core PCE basket is made up of these two categories. Price increases for the other two-thirds of core PCE were, on average, less than 2 percent over the previous 12 months, ending in November. Although I oppose disregarding our best estimates of housing and non-market service prices, it is noteworthy to me that in 2024, inflation and expectations of the policy rate path were driven by imputed prices rather than observed prices. In January, the higher inflation readings from the beginning of 2024 will finally start to decline. The 12-month inflation data through March should significantly decline as a result of this.

As it has occasionally done in recent years, geopolitical conflict may raise prices in the future. Furthermore, tariff plans increase the likelihood that a fresh source of inflationary pressures may surface in the upcoming year. The economic effects of these potential policy changes are predicted in a variety of ways. My opinion of the proper monetary policy is unlikely to be impacted by tariffs if, as I anticipate, they do not have a substantial or long-lasting impact on inflation. Naturally, we cannot truly consider the effects of policies until we have seen them implemented.

What do I think? I will be in favor of keeping our policy rate lowered in 2025 if the outlook develops as I have outlined here. The rate at which we reduce inflation while preventing the labor market from contracting will determine how quickly those cuts are implemented. The median of the policymakers’ anticipated appropriate policy rate for this year suggests two 25 basis point reductions, according to the most recent Summary of Economic Projections. 2 However, the opinions vary widely, ranging from no cuts to up to five cuts for various FOMC members. My main takeaway is that I think more cuts will be justified, but as always, the extent of additional easing will depend on how the data indicates our progress toward 2 percent inflation.

Moving forward, I will discuss some of the primary issues that I believe will influence monetary policy decisions for OECD members in 2025 and beyond. All of the problems I bring up are significant obstacles for all OECD nations, but some are more significant in some regions than others. Please do not take any cues from the order in which these challenges are presented, as I have not attempted to rank them in order of importance.

I’ll start by discussing the continuous difficulty all central banks have in meeting our inflation goals. The majority of central banks target inflation in the medium term, and indicators of the trajectory of future price changes, like core inflation, continue to run consistently above target, even though 12-month measures of headline inflation are close to target in the majority of jurisdictions. As inflation declines, the majority of OECD central banks are progressively loosening monetary policy, much like the Federal Reserve. In my opinion, policy is still generally restrictive, which should help policymakers achieve their long-term inflation targets.

As everyone is aware, the COVID-19 pandemic gave rise to this shared challenge in the upcoming months. The OECD economies differed greatly in their economic circumstances prior to and during the pandemic, as well as in the timing, intensity, and focus of their policy responses. Both supply and demand factors contributed to the pandemic’s spike in inflation, and although the period of the spike differed from nation to nation, research by Federal Reserve employees revealed that COVID inflation was primarily a worldwide phenomenon. 3.

All of our economies experienced inflation as a result of the disruption in the production and delivery of goods. 4 Inflation continued as a result of supply chains being repeatedly disrupted by waves of COVID variants and shortages of essential components. Delivery times have thankfully returned to their pre-pandemic levels as a result of these disruptions. Nevertheless, a number of geopolitical factors continue to influence supply deliveries, which may have an impact on inflation and economic activity.

The financial reaction to the pandemic has also been a typical experience. There is still disagreement over how much inflation was caused by the fiscal measures implemented to aid households and businesses during the pandemic. 5 Regardless of their impact on inflation, fiscal policy measures in OECD nations caused budget deficits as a percentage of GDP to double and triple, with even higher percentages in some regions. Although those deficits have gradually decreased since then, many nations still have larger deficits than they did prior to the pandemic, and many OECD members now have higher debt levels.

Widespread manufacturing weakness is another recent issue facing OECD economies. The start of the pandemic caused a boom in manufacturing in many areas as consumers began to spend more on goods rather than in-person services. However, the shift in consumer spending toward services as businesses and economies reopened with the lifting of pandemic-related restrictions marked the beginning of what has been a long-term decline in manufacturing in OECD economies. There are three more factors that have contributed to this slide. First, due to the capital-intensive nature of manufacturing, capital costs have increased in this sector due to interest rate increases over the past few years. This effect might reverse if monetary policy relaxes in other nations. Furthermore, manufacturing has suffered more than other industries from rising energy prices following Russia’s invasion of Ukraine. Finally, the OECD economies have been significantly impacted by China’s efforts to decrease its dependency on imports and increase its worldwide market share in industries like automobiles. Although manufacturing accounts for a smaller portion of the US economy than in some other OECD nations, we will see if the possibility of trade policy changes in the US has an impact on the decline in global manufacturing. S. . and somewhere else. Tariffs’ timing, magnitude, and effects are all very uncertain. All things considered, central bankers’ outlooks are made more uncertain by the development of manufacturing.

Geopolitical risk is and will continue to be a major short- to medium-term issue for OECD nations. Risks are higher, according to geopolitical risk indices, but not nearly as high as they were during Russia’s invasion of Ukraine in February 2022. But there isn’t much evidence of geopolitical risk having an impact on financial markets these days. However, geopolitical risk will continue to be a problem that central bankers must consider. As we have recently witnessed in Syria, the start of the wars in Europe and, more recently, the Middle East, were startling events that still have an impact. It is uncertain how these developments will ultimately impact global migration, trade, and security. The fact that these conflicts haven’t had a more significant impact on the world economy than they have thus far doesn’t mean they can’t or will. Research indicates that lower investment and employment are typically predicted by higher levels of geopolitical risk and, more generally, economic uncertainty. 6 In my opinion, central bankers in OECD nations will keep taking geopolitical risk into account in the medium run.

What I will call a “rethink of globalization” is the next challenge I want to discuss for central bankers, which has both short-term and long-term characteristics. For nearly ten years, numerous nations have been reevaluating the advantages and disadvantages of the increasingly unrestricted international flow of capital, labor, and goods that previously prevailed. Even though there hasn’t been a decline in global trade over the past ten years, there have been noticeable shifts in trade patterns, with more nations and businesses placing a higher priority on rerouting trade flows and cutting supply chains in order to avoid tariffs and geopolitical risk. This goes beyond a botched ministerial meeting or a bilateral dispute. Instead, it has been a long-standing, pervasive trend since a while ago. It is no longer as safe to assume that our economies and financial markets will continue to integrate more and more globally.

Changing demographics present another long-term problem. The population aging in OECD nations and, to a lesser extent, everywhere else is what I mean by this. For central bankers, this has some implications regarding long-term growth rates, productivity, and asset prices, even though it primarily affects fiscal authorities.

The percentage of Americans between the ages of 16 and 54 was 72% in 2003, 62.7 percent in 2023, and is expected to reach 61 percent in 2033. Other OECD nations are experiencing even faster aging. Although this is a gradual trend, employment and economic output decline as populations get older and transition from working to retirement. This alone affects inflation, investment, and consumption by lowering per capita GDP. The central bank’s estimate of the neutral policy rate may be impacted as asset prices and interest rates change as aging populations sell their accumulated assets to fund their consumption. Immigration, raising the retirement age, and increasing productivity growth for younger workers are some mitigants to lessen the impact of aging populations. Once more, fiscal policy is more impacted by these demographic factors, but monetary policy is also affected.

Another concern for central bankers is productivity growth, which has, I know, been discussed at OECD meetings over the past year. One set of estimates states that, in contrast to much smaller shares in other nations, labor productivity growth has contributed more than half of the cumulative GDP growth in the United States since the end of 2019. Even after years, it is difficult to pinpoint the precise technological and other factors that led to productivity growth, which is infamously erratic. 7 When determining how quickly their economies can expand without causing inflation, policymakers can benefit from having a basic understanding of the productivity growth trajectory. In order to determine whether wages can grow rapidly without causing inflation or whether potential growth has increased, central bankers must continue to monitor productivity. When evaluating the real neutral policy rate, or r*, productivity growth is also important. The interpretation of the degree of monetary accommodation or restrictiveness for policy is affected by higher productivity growth, which some policymakers often associate with a higher value of r*. 8.

Looking at the United States in comparison to other OECD nations is one way to try to understand some of the factors affecting productivity. Productivity growth in the United States is not a particularly new phenomenon. A. Certain economic disparities may have been more noticeable during and after the pandemic than in other developed economies. 9 First, compared to many other OECD nations, the United States experienced more job disruption during COVID, which may have helped match workers with new positions where they could be more productive once the pandemic ended. Secondly, during the severe U. A. During the 2022 and 2023 labor shortages, I heard many stories about how businesses had to increase worker training expenditures to bring skill levels up to par with job requirements. This may have been a significant factor recently and increases labor productivity with a delay. Third, it is evident that starting a business is simpler in the US, and new businesses are frequently more successful than those that already exist. A spike occurred in U. S. . business formation following COVID, which logically might have resulted in a more efficient redistribution of labor.

Perhaps there were other factors. Artificial intelligence (AI) was not one of them, in my opinion. Investment in AI will take many years, and it probably hasn’t increased productive capacity much thus far. AI might boost longer-term productivity growth, but that is still up in the air. However, those who attended OECD talks ten years ago would have recognized the other potential explanations, such as the loosening of labor laws, the ease of doing business, the obstacles to innovation, and the reduced regulatory obstacles. In the US, there are presumably fewer obstacles to creative risk-taking and more opportunities for reward.

Therefore, even though I don’t believe AI is significantly increasing productivity right now, I do think it will. AI and related computing advancements could boost productivity in labor-intensive, high-skilled services, much like robotics did in high-skill manufacturing. Creating an economy where people displaced by such a shift can acquire new skills and find fulfilling work will be a challenge for governments if such advancements do take place. As always, support for innovation that could lead to broad increases in living standards should be balanced with careful regulation. But innovation shouldn’t be stifled in its early stages by regulatory policy.

The proper approach to monetary policy hasn’t changed, and it shouldn’t, but there will always be new challenges. So, how should central banks respond to these challenges? Following our directives and avoiding the temptation to go beyond them is the first step in every situation. We need to keep a careful eye on the financial and economic landscape and continuously scan the horizon for new threats. We acknowledge that it is challenging to see all of these risks clearly in accordance with our mandates, so we must maintain our focus.

Additionally, we must be quick to react to new risks and ready to employ our monetary policy tools in novel ways in order to be ready for any unexpected obstacles. We must take deliberate action when circumstances are uncertain, as they frequently are, but we must also be prepared to respond swiftly and forcefully when necessary, as we did in controlling inflation. The public’s willingness to act on our intentions is a prerequisite for effective monetary policy. Credibility is also necessary for that, and it is best preserved when monetary policy decisions are made in accordance with our directives and toward the long-term goal of a sound financial system and a thriving economy. These fundamental ideas, in my opinion, will enable central bankers to meet the significant challenges of the present and the future.

1. My opinions are mine alone, and they may not represent those of my fellow Federal Reserve Board or Federal Open Market Committee members. Return to the text.

2. The Board’s website, located at https://www., has the most recent Summary of Economic Projections. The Federal Reserve can be found at fmccalendars.gov/monetarypolicy.gov. Go back to the text.

3. Both the core and noncore components of headline inflation measures, for instance, co-moved strongly across countries during the pandemic and inflation episode, according to Cascaldi-Garcia and colleagues (2024); see Danilo Cascaldi-Garcia, Luca Guerrieri, Matteo Iacoviello, and Michele Modugno (2024), “Lessons from the Co-movement of Inflation around the World,” FEDS Notes (Washington: Board of Governors of the Federal Reserve System, June 28). Return to the text.

4. For a preliminary explanation of how supply chain interruptions contribute to the worldwide increase in producer and consumer costs, see Ozge Akinci, Gianluca Benigno, Ruth Cesar Heymann, Julian di Giovanni, Jan J. J. Adam I. Groen, Lawrence Lin. Noble (2022), Liberty Street Economics (blog), Federal Reserve Bank of New York, “The Global Supply Side of Inflationary Pressures,” January 28. The article “Supply Disruptions and Fiscal Stimulus: Transmission through Global Value Chains,” published in 2024 by François de Soyres, Alexandre Gaillard, Ana Maria Santacreu, and Dylan Moore, discusses how supply disruptions spread to global value chains. 114, May, pp. 112—17. Go back to the text.

5. . Take, for instance, Robert J. Barro and Francesco Bianchi, “Fiscal Influences on Inflation in OECD Countries, 2020-2023,” Boston, Massachusetts: NBER Working Paper Series 31838, 2023. (Revised January 2025; National Bureau of Economic Research, November). NBER Working Paper Series 32859, “The Drivers of Post-Pandemic Inflation,” by Domenico Giannone and Giorgio Primiceri (2024) (Cambridge, Mass.). In August, the National Bureau of Economic Research published Karen Dynan and Doug Elmendorf’s paper, “Fiscal Policy and the Pandemic-Era Surge in US Inflation: Lessons for the Future,” which was published in December by the Peterson Institute for International Economics (PIIE Working Papers 24-22). Piie . com/publications/working-papers/2024/economic-policy-and-pandemic-era-surge-us-inflation-lessons-future. Scroll back to the text.

6. . View “Measuring Geopolitical Risk,” by Dario Caldara and Matteo Iacoviello (2022), American Economic Review, vol. pp. 112 (April). 1194–225; and “The Global Transmission of Real Economic Uncertainty,” published in the Journal of Money, Credit, and Banking by Juan M. Londono, Sai Ma, and Beth Anne Wilson (forthcoming). Go back to the text.

7. For an analysis of the variables influencing U.S. productivity growth. A. and whether they can support long-term development, see Christopher J. Waller (2024), “There’s Still No Rush,” speech, Economic Club of New York, New York, March 27. Return to the text.

8. The relationship between these series is discussed by Thomas Laubach and John C. Williams, “Measuring the Natural Rate of Interest,” Review of Economics and Statistics, chapter 3, 2003. Nov. 85, pp. John C., Thomas Laubach, Kathryn Holston, and 1063–70. Staff Reports 1063, “Measuring the Natural Rate of Interest after COVID-19 (PDF),” Williams (2023) (New York: Federal Reserve Bank of New York, June). Get back to the text.