Where Is the Fed Headed?

Independence, inflation, and communication

This post was meant to be a deep dive into the inflation data. Mostly, it still is. But this morning, the Supreme Court ruled in Lisa Cook's favor, blocking her removal from the Fed over unproven allegations. So monetary policy stays guided by data, like inflation, employment, and in the hands of the Fed, not the President. The same day's events also underscore why the Fed must explain what it's doing, and why. Three threads, then: independence, inflation, and communication — who decides, where inflation is headed, and what the Fed owes the rest of us.

Interest rates: Who decides?

At its heart, Fed independence is about who decides interest rates. Is it the technocrats at the Fed or politicians like the President? Today’s 5-4 Supreme Court ruling in Trump v. Cook was a win for interest rates set by economics, not politics, since it upheld the job protections for Fed officials. The narrow question was whether the President could remove Fed Governor Lisa Cook — fired over an allegation of mortgage fraud for which she has never been indicted, let alone convicted — while her challenge plays out in the lower courts. Chief Justice Roberts, writing for the majority, said no, explaining,

[Accepting the government’s position] would in effect transform the Federal Reserve’s for-cause protection into at-will employment—an interpretive leap out of step with the statute Congress enacted and our Nation’s tradition of central banking protected from political interference.

The White House asserted that the President’s decision for cause was unreviewable by courts. A decision in favor of the President would have allowed the White House to remove any member of the Board and pack the Fed with loyalists. The Supreme Court has shut down what would have been the President’s fastest path to getting control of interest rates. But it’s not over. They did not decide whether Trump had cause to fire Cook; that fight now returns to the lower courts.

It was uncomfortably close at 5-4. And in a companion case, Trump v. Slaughter, the Court handed the President at-will control over other independent agencies that had previously enjoyed job protections, such as the FTC. The Fed was the only carve-out.

Cook’s own words today capture the meaning of the ruling well:

This was never about mortgage documents signed years before I became a Federal Reserve governor. It was an attempt to remove me on a manufactured pretext because I refused to bow to political pressure and continued to set interest rates based only on what would best serve the American people. That is the most fundamental obligation of a Federal Reserve governor. Today’s ruling affirms a principle that has underpinned sound economic stewardship for generations: that the Federal Reserve must make all its policy decisions guided by evidence and independent judgment, free from political interference.

When Lisa Cook was nominated to serve at the Fed in 2022, I summed up the many ways she would contribute to policy: “The duties of the Board are many, and Cook will be the strongest all-around member.” I could not have been more correct. Cook will stand tall among the few who have defended the Fed’s independence. And with that defense, we can keep our attention squarely focused on the economy.

Inflation: Where’s it headed?

When talking about inflation, Kevin Warsh says “underlying pace,” Austan Goolsbee says “throughline,” and John Williams says “glide path.” Different words, same idea: where is inflation headed, on its own, if there aren’t any new developments or any changes in monetary policy?

Can we be confident inflation is headed to 2%? No, we cannot. Underlying or trend inflation is more likely to be between 2.5% and 3%. That’s good news relative to the current 4.1% pace, but it overshoots the 2% the Fed said it would deliver. That doesn’t mean that 2% inflation is out of reach; it just means either economic conditions will have to shift toward disinflation or the Fed will need to raise rates.

Getting from 4.1% down to that 2.5–3% trend doesn't take much; several one-off pressures are already unwinding. PCE inflation was 4.1% in May, more than twice the Fed’s target, but it's not a good read on where inflation is headed. The increase in energy prices from February to May due to the conflict in the Middle East added nearly a percentage point to inflation. Progress in June on reopening the Strait of Hormuz has already led to declining energy prices. While it will still take several months for energy prices to fully normalize, the move is already underway without any action from the Fed. In addition, there are clear signs in recent months that the pass-through of tariffs to goods prices is mostly complete, and core goods inflation has just started to cool (orange line below). A return to the pre-tariffs pace for core goods would subtract more than 1/2 percentage point from overall inflation. Reversing the effects of energy and tariffs on inflation alone could bring inflation back to 2.5%.

Rather than relying on stories about specific components, statistical approaches can identify the persistent part of inflation. A common assumption is that outliers—very large increases or very large decreases in prices—tend to be one-offs or temporary. Outliers can distort simple averages like headline inflation. Likewise, core inflation, which excludes food and energy, can still be distorted by outliers that are not food or energy. Median inflation, the middle of the price distribution, and trimmed-mean inflation, which excludes the highest and lowest price changes, are alternatives. The PCE trimmed mean from the Dallas Fed removes the bottom 24% and the top 31% of the distribution, so it can be sensitive to shifts between positive and negative outliers. The skew-adjusted trimmed mean developed at the Cleveland Fed corrects for that. Taken together, these alternative measures (especially after the skew adjustment) are consistent with a 2.5%-3% trend.

What's left? Non-housing core services account for that last half percentage point of trend inflation above 2%. Like overall PCE inflation, the excess here is mixed in how likely it is to persist. Within transportation, higher airfares — driven by the recent surge in jet fuel prices — are likely temporary. In financial services, the big mover is portfolio-management fees — charged as a percentage of assets, so a rising stock market mechanically shows up as inflation. An upcoming BEA change will base these prices on the service provided rather than the market, likely revising current inflation down. The rest of the excess in non-housing core services is stickier — health care, for example, which is full of administered prices. And across many labor-intensive services — recreation, hotels, restaurants, and other personal services — inflation has stayed persistently above its pre-pandemic pace. One might argue this is the "cost" of the soft landing.

A good read on where inflation is headed is critical to whether the Fed needs to move rates. But trend is not destiny — even a 2% trend is no guarantee of price stability, since actual inflation can diverge from trend as it does now.

Communication: What’s the goal?

The Supreme Court sees the Fed as special in its independence from political control, and at a moment when inflation is one of voters' top concerns. Monetary policy won't be made by politicians, but it will have political consequences and shape the lives of millions. That's a lot of power to entrust to Fed officials.

To keep that trust and maintain independence, the Fed's guiding principle in communication should be transparency in service of accountability. The Fed cannot guarantee that unemployment and inflation will be low, but it can guarantee it will pursue those goals diligently and show its work. Hiding behind jargon or staying quiet won't deliver.

Last week on Bloomberg, I was asked a question that stuck with me:

Ferro: “You have been inside the Fed and watching the Fed. If you had free rein of the institution and could readjust — adjust the communication apparatus at the Federal Reserve — what would you change? What would you get rid of?”

I fumbled a bit — 6:45 am, no coffee — but the themes came through:

Sahm: “Goodness. In the time I was at the Fed — I started in 2007 — I watched a Fed become more transparent, more speaking to the public. I think it is very important for accountability’s sake that the public, the Congress understands what the Fed is doing, why they are doing it. Sometimes it will be clear they made a mistake. Sometimes if you show your work it will be clear you made a mistake. I think the accountability piece is important. The fine-tuning of how the Fed gives information so markets can understand it and help the Fed do its job — part of how it works is through financial markets — there is a lot of fine-tuning. The dot plot is not a perfect tool in any form, but the spirit has real merit… I worry that it is very easy to delete things, delete tools. But that doesn’t necessarily move the ball forward in terms of improving the goal-setting, improving the transparency.”

Once you have the principle right, then the tinkering on the apparatus can be more targeted. My long-standing concern with the dot plot is that it’s hard for people to understand. I have a PhD in economics, listen to almost all the Fedspeak, and I still have to make guesses with the dot plot. I can list my preferred tweaks, but honestly, that's a sideshow to getting the Fed to elevate transparency and accountability. Members of Congress and regular people are just as important as financial market participants.

Communication is not primarily about keeping financial markets informed on monetary policy. It’s about keeping monetary policy in the hands of Fed officials. The Fed is special, and it needs to act like it.

In closing.

The Court preserved the Fed's independence, which deepens the stakes for getting monetary policy right and being accountable to the public. Fed officials setting rates answer to the evidence, not the President, so reading the data right is critical. That evidence points to trend inflation somewhat above 2%, an overshoot that might necessitate higher interest rates, or it might not. In either case, it’s important for the Fed to lay out its thinking. Transparency and openness to feedback can’t substitute for good economic outcomes, but they should be part of the pursuit. That’s how the Fed can help protect its independence and keep monetary policy driven by economics.