Between Easing and Anchoring: How the Fed Navigated the Final Mile of Disinflation in July 2025

Milton Ayoki

MPRA Paper from University Library of Munich, Germany

Abstract: By July 2025 the Federal Reserve confronted the most treacherous phase of post-pandemic disinflation—“the final mile” in which the last half-percentage-point of inflation proves harder to expunge than the first four. Headline PCE had fallen from 7 % in mid-2022 to 2.5 %, yet core services inflation, amplified by tariff-driven cost-push shocks and still-elevated wage growth, refused to converge to the 2% target. Meanwhile, payroll gains had slowed to a crawl (73 k in July), the unemployment rate had drifted up to 4.1%, and financial markets were pricing two 25 bp cuts before year-end. This paper reconstructs the FOMC’s July 29-30 deliberations—held against a backdrop of White House pressure, a flattening yield curve and an ongoing framework review—to show how the Committee balanced the competing risks of under-tightening (un-anchoring expectations) and over-tightening (precipitating a recession). Using the newly released minutes, high-frequency market data and a calibrated New-Keynesian model, we argue that the decision to hold the federal-funds target at 4.25-4.50 % can be interpreted as a state-contingent “flexible anchoring” strategy: keep policy moderately restrictive today while signalling that even a modest deterioration in labor-market momentum would justify insurance cuts as early as September. Counterfactual simulations indicate that the chosen path shaved 15 bp off the term premium, reduced the probability of a 2026 recession by one-third relative to a hawkish baseline, and kept 5y5y inflation expectations anchored at 2.05%. The episode illustrates how a transparently data-dependent reaction function can substitute for explicit forward guidance when the economy is buffeted by supply-side shocks whose persistence is unknown.

Keywords: Federal Reserve; inflation expectations; monetary-policy rules; fiscal dominance; supply shocks (search for similar items in EconPapers)
JEL-codes: E31 E52 E58 (search for similar items in EconPapers)
Date: 2025-08-20
New Economics Papers: this item is included in nep-cba and nep-mon
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