In the last 3 weeks we’ve seen three big macroeconomic events
1. The release of the Consumer Price Index (CPI) CPI July 15, 2025 and Personal Consumer Expenditure (PCE) the latter big the Fed’s target rate of inflation June on July 31, 2025.[1]
2. The meeting of the Fed’s Federal Open Market Committee, July 30, 2025, and decisions not to change the Effective Federal Funds Rate, “interest rates,” albeit with two unusual dissents.
3. The release of June estimate of payroll jobs and large downward revision of the April and May estimates, Aug 1, 2025.
In the context of GDP growth in the first half of 2025 of 1.2% compared to 2.7% in the second half of 2024.
What narrative should we attach to these events?
One is that the Fed made a huge mistake. The uncertainties arising from the on and off tariffs, and deportations have caused a drop in aggregate demand (an increase in the demand for safe assets) and a fall-off demand for labor. Weakness in the labor market was the basis for Governor Chris Waller’s dissent from the FMOC decision. (AI deployment gets mentioned here, even though it – supposedly – affects only the demand for labor, not an aggregated demand story). Rather what demand there is – and the DJIA’s joyous ride -- is buoyed by a race to build AI data centers. The modest increase in inflation indicators is temporary and that the Fed should “look through” and reduce interest rates to deflect the economy from “tipping” into recession.
Claudia Sahm, on the other hand, argues that what we are seeing in the low employment growth and slowing GDP growth is more a fall in aggregated supply – less immigration/deportations.
In addition, in May, the Supreme Court allowed the Trump administration to terminate the Temporary Protected Status program protecting 350,000 Venezuelan immigrants and a humanitarian program with more than 500,000 immigrants from Cuba, Haiti, Nicaragua and Venezuela. These affected persons also lost any work authorization that they had obtained under the programs. Only a portion of the group was working, but is a sizable, abrupt change. There were news reports at the time of companies like Walmart and Disney laying off affected workers.
Taking the demand narrative head-on, Sahm argues on the basis of wage growth there is slow growth in supply of labor rather than demand for labor.
The stability of the unemployment rate masks effects of the low-hiring, low-firing labor market. The share of the unemployed who were permanently laid off has moved down in recent months, while the share who are new entrants to the labor force has edged up. Likewise, initial unemployment insurance claims have moved down since the start of June. These are not typical patterns of a deteriorating demand for labor.
She also draws attention to the tariff increases as ongoing process; firms are only now beginning to pass tariff increases through to users. Robin Brooks concurs :
Two categories in the CPI and PCE indices - furnishings and recreational goods - are currently adding almost 10 bps to monthly inflation over what we'd normally see at this time of year. These are goods imported mostly from China. A huge inflation shock
These effects on prices will continue even if no new tariffs erupt. [But who is to say that Mt. Trump is at last dormant.]
Nevertheless, Sahm did NOT want the Fed to accommodate these relative price movements and therefore agreed that the Fed should not have cut the EFFR in August (much less earlier earlier).
Although I am persuaded by Sahm’s aggregate supply vs aggregated demand story, the case for the cut is that tariffs and deportations, if large enough and concentrated enough can disrupt up relative prices -- some need to rise and others to fall to maintain full employment of resources (not just of labor, but labor is not a bad approximation of "resources"). Some prices, however, cannot fall, so for THOSE relative prices to fall other prices have to rise, which means that the average of all prices has to rise - inflation. Negative supply shocks like the increase in tariffs and the deportations could spur the Fed to crank up some additional inflation to facilitate these needed relative price movements and reduce the EFFR to do so.
In addition, there is a separate argument for a rate cut now that goes as follows. The uncertainty stemming from the way tariffs are announced an unannounced and the effects of the deportations, the effects of DOGE/One Budget Busting Bill/recission could be causing consumers and investors to hang back, threatening a good old-fashioned lack of aggregated demand recession like 2008- as Brad DeLong articulates:
[The average monthly number of jobs created 86,000 compared to PIIE’s Jed Kolko’s estimate of new labor supply, 85,000] is smack-equal to what we have seen so far in 2025. An economy not at stall speed for the year as a whole so far, but worryingly close, and slowing down significantly over the past three months.
And in this case as well, the Fed should employ good old fashioned monetary stimulus, a cut in the EFFR.
Were the slow growth numbers and low employment growth numbers indicative of tariff-deportations causing unemployment of resources enough that the Fed should cut? That's the Fed's job to continuously figure out.
Personally, I’m more persuaded of the arguments for a cut, but I’ll also say that my distaste for inflation is probably less than Jerome Powell’s, so I see less downside risk of too much inflation too soon to deal with tariff/relative prices and or uncertainty/aggregated demand.
Image Juglar with three balls in the air. [The third hand helps 😊]
[Standard bleg: Although my style is know-it-all-ism, I do not deny that I can be mistaken or overstate my points. I also know there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]
[1] In the chart I have shown the data as equivalent deviations from the Fed’s 2% p.a. inflation target.
Thanks for the summary from Sahm! I read her post the other day. This post reads like introductory macroeconomics (in a good way! It was easy to follow the logic.) I agree with your conclusion. Don't ask me about the specifics of price indexing though. :)
"She also draws attention to the tariff increases as ongoing process; firms are only now beginning to pass tariff increases through to users." This follows what I said a couple weeks ago in terms of lagged effects. Just as a personal example, I was at a furniture store a few months ago. They said they front loaded inventory in anticipation of tariffs, so in a few months, their prices would increase. We are now at that point.