What to understand about the Fed’s inflation outlook due this week

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Last year, the Federal Reserve lowered interest rates three times following a long tightening campaign to cool pandemic-era inflation and restore price stability. This week, the first cut of 2025 is on the table, with the Federal Open Market Committee meeting Sept. 16-17. However, inflation remains stubborn, tariffs are adding intermittent pressure, and the labor supply is changing.

To learn more about what counts as inflation and how the Fed responds to it, Penn Today spoke with Patrick T. Harker, former president and CEO of the Federal Reserve Bank of Philadelphia and now Rowan Distinguished Professor at the Wharton School, and Harold L. Cole, James Joo-Jin Professor of Economics and Finance in the School of Arts & Sciences.

What is inflation?

“Inflation is the increase in the price level,” Harker says. A one-time jump—say, a tariff that raises prices and then stops—pushes the level up but isn’t inflation. “It’s the ongoing climb that counts,” a distinction policy makers watch closely, he says.

Why the target is about 2%

Harker notes that economies need a little inflation. “Zero sounds great, but it could potentially then get into a deflationary cycle,” he says. That’s why most central banks aim for about 2%.

Cole adds that if inflation is running at 2% and the real rate is 1%, then the nominal rate, the sticker number we actually see, is about 3%. Starting at 3% gives the Fed room to cut interest rates in a downturn without immediately dropping to zero. At that point, monetary policy becomes much less effective, Cole says.

What the jargon means

Headlines often treat the Consumer Price Index (CPI) as “inflation.” It’s related, but it’s one of several measures the Fed watches.

Cole explains that CPI tracks a fixed basket of goods based on what households report buying. Because the basket stays fixed, it doesn’t capture how shoppers switch to cheaper options. If steak gets pricey and people buy chicken, the CPI still prices the steak-heavy basket, so measured inflation can look higher than what households actually pay.

By contrast, the Personal Consumption Expenditures measurement is broader and adjusts for those shifts, which is why the Fed often prefers it. The Producer Price Index (PPI) is another measure that looks at prices received by producers and can foreshadow moves that later show up in consumer indexes.

Cole notes that the recent PPI came in softer, even as 12-month consumer inflation has hovered nearer 3%. The mix of measurements is complex and not cleanly directional, which is why officials watch all three.

What the Fed controls

“Ultimately, the Fed only controls one interest rate, the federal funds rate the rate banks charge to each other to borrow money overnight,” Harker says. “What we as consumers care about—mortgage, auto, and credit loan rates—are tied to longer term treasuries, those the Fed does not directly control. The market controls.”

Because of that, communication matters. “The Fed influences rates mainly by what we call ‘forward guidance,’” or statements that shape market expectations in real time, Harker says. Every meeting of the Fed brings a policy statement. Every other meeting brings the Summary of Economic Projections, including its famed dot plot, with each dot representing the 19 Fed members’ anonymous forecasts for growth, inflation, and rates.

“The Fed doesn’t publish a single consensus; it publishes the full constellation, tight or scattered,” Harker says, noting how he expects a wide dispersion of dots at this week’s meeting that reflects genuine disagreement about where policy should land.

Why jobs don’t paint a clear picture

Two big surveys drive the labor numbers: one from firms, one from households. “There’s a lot of dispersion right now,” a sign of measurement issues that make any single print unreliable, Harker says.

Cole identifies a few reasons behind the recent revisions, including fewer survey responses since COVID and a changing mix of new and closing firms that older benchmarks don’t capture. He says immigration and demographics are also playing a role in the jobs numbers, with immigration appearing to have slowed, and slow growth among the U.S.-born workforce, which structurally limits labor supply.

“The immigration piece is affecting not just the labor market but also economic growth,” Harker says. He says that in sectors such as agriculture, employers rely heavily on immigrants, which causes issues with crop harvests and subsequent exports.

Harker also underscores the macro impact; cutting back on inflows isn’t trivial because “immigrants not only do the work, but they also purchase stuff and pay rent. They have a positive economic impact and are a net positive,” as the Wharton Penn Budget Model’s analysis shows.

Harker doesn’t just watch “hard” data but also leans on “soft, anecdotal data” from conversations with business contacts, and points to the Philadelphia Fed’s Manufacturing Business Outlook Survey as a useful pulse check on hiring and growth in the region.