Paulson Signals Open Mind on Rates as Inflation Stall Raises Policy Doubts

Philadelphia Federal Reserve President Anna Paulson kept her options open on Tuesday on the next move for U.S. interest rates, saying she needs to see more progress on underlying inflation before she is convinced the current policy stance is working.

In her first CNBC interview, Paulson said she was confident in her vote last week to hold the Fed’s benchmark rate at 3.5%-3.75%, but she described her outlook as genuinely uncertain.

"I think we need ... policy that's mildly restrictive, and I think policy has been mildly restrictive to get underlying inflation back down to 2% in an acceptable time period," Paulson told CNBC. "I need to see progress from here."

The comments, echoed in an essay published Tuesday, mark her first public remarks since last week’s Federal Open Market Committee meeting, where officials left rates unchanged for the fifth straight meeting. The decision carried a 9-3 tally, with three dissenting policymakers arguing for a quarter-point hike on the view that current rates are not restrictive enough.

For Paulson, the choice was simple.

"For me, it was not a close call," she said.

The debate inside the Fed has centered on how much restraint the current rate level is actually exerting on the economy. Paulson said she sees two plausible readings of the evidence.

In the first, further improvement in inflation data and stable inflation expectations would confirm that rates are "mildly restrictive" and moving price pressures back to the Fed's 2% goal "in an acceptable time frame." In the second, the fact that underlying inflation has "edged down modestly" over the past year could instead signal that rates are "not restrictive enough."

"The evidence so far suggests we're in a mildly restrictive stance," she said in the CNBC interview, adding that she now needs to see more progress on underlying inflation measures.

Paulson estimated underlying inflation, stripped of energy supply shocks, tariffs and other factors, is running somewhere between 2.4% and 2.8%. That is above the Fed’s target but below the 3.3% reading on the core measure the central bank treats as its primary forecasting tool, as reported by the Commerce Department in June, according to CNBC.

Recent data has offered the Fed some relief. The personal consumption expenditures price index — the central bank’s preferred inflation gauge — fell 0.1% in June, with measures excluding food and energy rising less than expected, Bloomberg reported. Inflation-adjusted consumer spending rose 0.4%, matching the strongest pace since July of last year.

"The recent improvement in some inflation data is welcome. It is a step in the right direction, but it is only one step," Paulson wrote in the essay.

That one step will not be enough on its own. Paulson made clear that if the recent cooling does not continue, she is prepared to act.

"If we don't see that progress, then we have to be open to recalibrating monetary policy," she said. "We need to get to 2%."

Asked what a stronger response might look like, Paulson said it "could be higher rates, could be, you know, same rates for longer."

She also signaled openness to institutional changes floated by Fed Chairman Kevin Warsh, including a potential reduction in the frequency of FOMC meetings from the current eight per year. "It's healthy to have a discussion about that," she said. Warsh, in his press conference after last week's meeting, declined to offer guidance on the likely direction of policy.

Paulson stressed that the ultimate objective remains unchanged. "My highest priority is delivering 2% inflation while sustaining full employment," she said.

On the labor market, she said conditions appear stable, though inflation remains "too high." She also addressed the role of energy-driven supply shocks in the policy calculus, pointing to recent volatility in oil prices tied to the Middle East conflict.

"We saw there that when we had the lull in the conflict in the Middle East, oil prices came down," Paulson said on CNBC, adding that a monetary policy response would have been too slow to matter. "If I had tried to affect that through monetary policy ... I would have been ... too late, it wouldn't have hit at the right time, so ... that's the logic for looking through supply shocks."

The essay laid out the same caution: oil prices have jumped and remain volatile, but the brief period of Middle East stability showed that supply shocks can be temporary, reinforcing the case for looking through such disruptions when setting policy.

The net message from Paulson is one of deliberate ambiguity — a Fed official comfortable with where rates are today, but unwilling to promise they will stay there.

"I am committed to keeping an open mind as I assess the evidence and determine the appropriate path for policy," she said.

For markets, that leaves the key question unresolved: whether the current hold is a pause before a hike or a longer plateau. Paulson’s answer, at least for now, is that the data will have to decide.