Core inflation is 3.3 percent. The Fed’s rate may not be restrictive at all.
A Kansas City Fed president says the 3.5-3.75 percent policy rate may not be restricting anything.
By The Ledger · · 4 min read
Core inflation ran at 3.3 percent in July, the Commerce Department reported on August 27. The Federal Reserve's target is 2 percent. The next day, Kansas City Fed President Jeffrey Schmid said he does not know what the central bank's current interest rate is actually restricting.
That is an unusual thing for a Fed official to say out loud. The whole premise of a "restrictive" policy rate is that it slows borrowing, spending and hiring enough to cool prices. If nobody can identify what it is slowing, the rate is doing less work than its number suggests.
3.5 to 3.75 percent is the rate. 3.3 percent is the reason it might not be enough.
The Federal Reserve's benchmark sits in a range of 3.5 percent to 3.75 percent, set through 2026's rate decisions. Core personal consumption expenditures inflation, the Fed's preferred gauge because it excludes volatile food and energy prices, rose 3.3 percent year-over-year as of July, the Commerce Department said on August 26. Second-quarter GDP grew 1.5 percent. Unemployment sits at 4.1 percent.
Put those together and the math gets uncomfortable. A policy rate is meant to sit above inflation by enough to make holding cash, or borrowing to spend, less attractive than saving. Subtract 3.3 percent inflation from a 3.5-3.75 percent rate and the real, inflation-adjusted return is somewhere between 0.2 and 0.45 percentage points. That is barely positive. Schmid's point, made on CNBC's "Squawk Box" on August 27 from the Kansas City Fed's Jackson Hole symposium, is that a rate barely above inflation cannot be assumed to be squeezing anyone.
The number sounds high. Against inflation, it barely clears zero.
A 3.5-3.75 percent policy rate looks restrictive next to the near-zero rates of 2020-2021. It looks different next to 3.3 percent inflation. Economists call the gap between a policy rate and inflation the "real rate," and a near-zero real rate has historically coincided with easy, not tight, financial conditions.
Schmid was already on record doubting the case for cuts. As a voting FOMC member last year, he dissented twice against rate reductions. His new argument goes further: he is not certain the current rate restricts demand at all, which would mean the Fed has not been leaning against inflation as hard as the headline number implies. "I don't know what we're restricting currently with the rate policy that we're at today," he said. He stopped short of calling for a hike, saying he needs more data on what is driving demand.
Bond markets are pricing the doubt Schmid is voicing.
The skepticism is not confined to one Fed regional president. UK government borrowing costs rose to their highest level since 2008. Japanese government bond yields climbed to levels unseen since the 1990s. Global bond markets have been repricing since late August, with investors demanding higher yields to hold long-dated government debt across the UK, Japan and the US.
That repricing is the market's own verdict on sticky inflation. When core price growth refuses to fall toward target, bond buyers demand more compensation for the risk that inflation stays elevated, or that central banks stay behind the curve. Higher government bond yields flow directly into mortgage rates, corporate borrowing costs and student loan pricing. A pension fund holding 30-year UK gilts bought at 2008-era rates is now sitting on a mark-to-market loss it cannot easily escape without booking it.
The counter-argument: growth is already slowing, so the rate might be doing enough.
The strongest case against Schmid comes from the growth number itself. GDP grew at just 1.5 percent in the second quarter, a rate well below the roughly 2 percent long-run trend the US economy has managed over the past decade. If demand were genuinely unconstrained by borrowing costs, growth would likely be running hotter, not slower. Unemployment at 4.1 percent is also up modestly from the sub-4 percent lows of 2023, a sign that hiring has cooled somewhat.
Schmid's own answer is that he cannot yet separate cause from coincidence. "What I'm trying to figure out is the demand side of what's driving both growth and inflation," he said. That is an admission that the Kansas City Fed does not currently have a model that cleanly attributes slower growth to the policy rate, rather than to other forces such as tariffs, energy costs, or slower immigration-driven labor supply growth.
The FOMC calendar itself may shrink, which changes how often this argument gets settled.
Schmid also said he sees "some room" to consider Fed Chairman Kevin Warsh's July proposal to cut the number of FOMC meetings per year from eight to six. Fewer meetings mean fewer scheduled moments for the committee to revisit whether the rate is restrictive, which raises the stakes of each decision that remains. A rate-setting body that meets six times a year, rather than eight, has less room to make small adjustments and more incentive to wait for conclusive data before acting at all.
Schmid does not hold a vote on the FOMC this year, so his words carry no immediate procedural weight. But he attends the meetings and speaks at them, and his framing echoes concerns already showing up in bond yields from London to Tokyo. If the person overseeing one of the twelve regional Fed banks cannot say what the current rate restricts, savers holding bonds at today's yields, and borrowers refinancing mortgages at today's rates, are the ones absorbing the uncertainty until the FOMC decides whether 3.5-3.75 percent needs to move higher, lower, or nowhere at all.