MNI INTERVIEW: Nimble Fed Needed To Tackle Slowdown -Koenig

Federal Reserve officials must be willing to entertain more aggressive easing amid new signs of slowing nominal demand growth and restrictive monetary policy, Evan Koenig, former senior aide to the president of the Dallas Fed, told MNI.   

Last week's second quarter GDP report showed a marked slowdown in nominal demand measures to rates more consistent with 2% inflation over the long run. It is indicative of monetary policy that has shifted to a restrictive stance after months at neutral, and the FOMC should be prepared to take action to keep demand from further decelerating, Koenig said.       

"In a way this is encouraging to see the slowing in demand growth, but it could easily get out of hand and policymakers need to up the level of vigilance right now. We’re in a dicey situation and you have to be prepared to be nimble on policy," he said in an interview.  

"That does mean the outlook is more uncertain. You could see a larger-than-expected move. It’s certainly within the realm of possibilities." (See: MNI INTERVIEW: Fed September Cut Not Assured - Rosengren)

NEUTRAL RATE FALLING

Until recently, Koenig deemed monetary policy to be approximately neutral, with the economy running at full employment, steady demand growth and inflation hovering above target in a 2.6%-2.8% range. 

But a likely fall in the short-run neutral real interest rate as uncertainty over President Trump's tariffs froze consumer and business decision-making alike has rendered policy restrictive, in spite of the FOMC keeping rates on hold this year, Koenig said. 

Growth in nominal final sales to private domestic purchasers, a core measure of demand that strips out government spending, inventories and net exports, fell back to 4.7% (annual percent change) in the second quarter after holding steady in a 5.25%-5.5% range over the past year, while the more volatile nominal GDP growth measure dropped to 4.5% from 5%-plus. 

That slowdown has primarily occurred over the first two quarters of 2025, which saw 4.1% growth in both nominal GDP and nominal private domestic final purchases, Koenig noted. (See: MNI INTERVIEW: Tariffs Pushing Services Into Contraction - ISM)  

"There’ was no reason to be happy with where we had been, but there was some stability there. What we may be seeing are the first signs of a policy shift to a restrictive policy stance," he said. "Holding the funds rate constant is by no means the same thing as holding the stance of policy constant." 

EMPLOYMENT IN GOOD SHAPE

The FOMC is in a tricky situation also because policymakers can't be sure whatever reduction in the neutral real rate that has occurred could be transitory – lasting only as long as trade uncertainty persists, Koenig said. 

"That would be a justification for the wait-and-see attitude that the FOMC has taken, hoping that enough uncertainty will resolve itself that by the next FOMC meeting they'll have a better idea of what to do," he said. 

And despite a July jobs report showing the worst three months of hiring since the pandemic, the labor market continues to be in good balance, Koenig said. 

Measure of slack – the unemployment rate and unemployed-to-vacancies ratio – have varied within very narrow ranges over the past year, and we have yet to see a surge in layoffs or initial claims for jobless benefits, he said. 

"All of these things suggest we’re not past the tipping point."