The heads of the Federal Reserve are all determined to stop the worst inflation in 40 years. They still want to reach their goal, but they can’t agree on how high to keep U.S. interest rates.
Last week, the central bank cut interest rates for the third time this year. The vote was almost unanimous. Senior officials, on the other hand, seemed to be split into several groups over how much further to go in the next few years.
One of the main points of disagreement is how hard the Federal Reserve should try to bring inflation down to its goal of 2% and how high U.S. interest rates will need to stay for that to happen.
When asked about predictions for the benchmark fed-funds rate, FHN’s top economist Chris Low said, “There is no hint of consensus.” In 2026, most top Fed officials said those rates were between 3.1% and 3.9%.
Wall Street, if not Main Street, is paying close attention to how the argument turns out.
Inflation angst
Until a few months ago, inflation seemed to be closing in on the Fed’s 2% target. The central bank’s preferred inflation barometer, the personal consumption expenditures index, slowed to a 3½-year low of 2.1% in September, down from a 40-year peak of 7.3% in 2022.
‘Inflation is proving to be more stubborn than many had anticipated.’
Richard Moody, Regions Financial
The annual rate of inflation has gone back up to 2.4% as of November, though, after several months of higher-than-expected price reports.
Also, Fed officials think it’s likely that inflation will be a little higher at the end of 2025 than it was at the end of 2024. The government raised their estimate for 2025 to 2.5%.
“Inflation is being more stubborn than many people thought it would be,” said Richard Moody, chief economist at Regions Financial.
Interest rates in the U.S. may stay higher than the Federal Reserve would like because they don’t know where inflation is going.
Fed officials cut in half the number of rate cuts they think will happen in 2025, to just two. In September, they thought that rates would go down four times in the next year.
Because of this, it costs more to borrow money for people buying homes and cars and for many businesses, big and small, that were looking for more rate relief soon.
But because of the split in the central bank, even the chance of two rate cuts in 2025 is not a sure thing.
Putting the “dots” together
The difference was made clear by the “dot plot,” which shows what the 19 top Fed officials—seven board members in Washington, D.C., and 12 heads of regional Fed banks—thought.
It was a 10-1 vote, but four top officials did not want to lower interest rates last week. One of them, new Cleveland Fed President Beth Hammack, spoke out against the decision. Each year, only 12 of the 19 top officials are on the Fed’s group that decides interest rates.
A lot of people at the Fed don’t agree with this.
Hammack said she needed more proof that price pressures are letting up once more. She said in a statement, “Inflation remains high, and recent progress in getting inflation back to 2% has been uneven.”
That’s not all—Hammack also said she thinks the Fed is already pretty close to the “neutral rate.”
The idea is about the best amount for the Federal Reserve’s benchmark interest rate, which is one that doesn’t speed up the economy too much or slow it down too much.
What is not neutral?
That would mean that the Fed would only lower its key interest rate by another 50 to 75 basis points if it was already very close to neutral. After the drop last week, the rate was between 4.25% and 4.5%.
Hammack is one of six top Fed officials who think the bank’s neutral rate is getting close.
An even bigger group of eight officials, possibly including Fed Chair Jerome Powell, thinks the neutral rate is much lower, maybe 3% or less.
“I don’t think we are at the long-run neutral rate [real rate] at all,” Powell’s close friend and fellow New York Fed President John Williams said. “The neutral rate might be a little higher than we thought, but it’s still not near where we are now.”
The Federal Reserve might lower its key interest rate by a lot more in the future if he’s right.
A third, smaller group thinks that rates can be lowered even more.
The way ahead
Of course, which of these ideas wins out will rest on how much inflation drops over the next year. If the current rise in inflation turns out to be a one-time thing, the Fed could cut rates three or more times in 2025.
The head of the Chicago Fed, Austan Goolsbee, said last week that rates can still go down a fair amount in the next 12 to 18 months.
The wish of Goolsbee and others to cut rates is due to another reason. A few Fed officials who backed the rate cut last week are less worried about inflation and more worried about how the economy might be affected by the U.S. job market getting worse.
In order to keep the current economic growth going, they are likely to cut rates a bit faster, even if inflation stays a bit high.
Last week, San Francisco Fed President Mary Daly said, “What I hear more than you would think is, don’t get one-tenth off inflation and break the economy.” “I don’t want the unemployment rate to go up just so we can reach our 2% goal a quarter early.”
Trump is coming to power as president, and he has been a harsh critic of Powell as Fed chair during his first term. It will be hard for Powell to bring these different views together at the Fed. It’s not going to be easy.
But don’t expect any big bangs in the coming year. When the Fed debates something, it’s more of a polite conversation than a rough intellectual fight.
Powell also has a lot of backing inside the central bank. It’s very rare for the head of the Fed to lose a vote, let alone have a lot of people disagree with them.
In the 1980s, when the U.S. economy was going through some of its worst times, Paul Volcker was the last Fed head to lose a key vote.
