The Rooms Driving the Economy

Thanks for the kind introduction, and for inviting me to join you today. I often get asked about our Federal Open Market Committee (FOMC) meetings. People understandably want to know what it’s like in “the room where it happens,” to quote “Hamilton.” I’m always happy to share what I can. But then I like to point out that the economy doesn’t happen in a single meeting room in D.C.; it happens in rooms across the country where businesses and households like yours make decisions.

Lately, as I’ve been thinking about the economy, I’ve been thinking about the choices made in these rooms. Today, I’ll walk through what I’m hearing is happening in three of them, and then I’d like to hear from you what I’m missing. Don’t worry, I’ll say a few words about the FOMC meeting room, too. These are my thoughts alone and not those of anyone else on the FOMC or in the Federal Reserve System.

The Boardroom
I’ll start with the boardroom, where business leaders are busy planning for 2027.

Earnings this year have been remarkable. For the S&P 500, second quarter median earnings grew an impressive 15 percent. Aggregate earnings growth was a hard-to-fathom 31 percent. Third quarter earnings have been coming in comparably. Of course, not every sector has been equally healthy, and large businesses are faring better than small — but in aggregate, businesses are performing quite well.

Strong earnings have been driven by explosive growth in the tech sector, and by unexpectedly robust demand boosting the bottom line for companies that had planned conservatively. They’ve also been bolstered by healthy underlying productivity growth, subdued wage pressure, and pricing power sufficient to offset recent cost increases. Windfalls from tax changes, tariff refunds, and the drawdown of lower-cost inventories have also helped.

Strong earnings influence decisions taken in the boardroom:

Healthy firms invest: Business investment in the third quarter was up 12.7 percent. Artificial intelligence (AI), of course, is a big part of this story, as is defense. But bankers tell us loan pipelines are healthy, with demand extending beyond the AI buildout.

Healthy firms are reluctant to lay off workers: They may be dragging their feet on hiring in the context of uncertainty and the potential of AI, but they are not firing. Layoffs remain muted. Initial unemployment claims are at 55-plus-year lows.

Healthy firms can afford to be patient in passing on cost increases: Perhaps that was behind the relatively muted inflation readings we saw in early summer. Multiple firms have told us they held off cost pass-through when they thought the conflict in the Middle East would be short-lived.

I do wonder how long this earnings strength can last. We are hearing widespread reports of broad-based cost pressures. Health insurance. Gas and diesel prices. Trucking and ocean freight. Business travel. Memory chips. Interest rates. Tariffs. And, of course, demand could falter and external uncertainty remains elevated.

The question is how businesses will react to margin pressure as we move into next year. Will they find new avenues for growth? Scale back headcount and investment? Or find a way to recover these costs by raising their prices further?

The Kitchen
That brings me to the kitchen, where a financially stretched couple or a single parent might well be trying to figure out how to make ends meet.

Consumer sentiment is bleak. The University of Michigan Index of Consumer Sentiment has recorded its five lowest months ever this year. Inflation has been above our 2 percent target for over five years now. September PCE came in at 3.6 percent headline and 3.1 percent core. Wages are up comparably during this high-inflation period, but it sure doesn’t feel like that.

But despite flattening real incomes, consumers are finding ways to keep spending. Nominal consumption excluding food and energy has grown at an annualized rate of 6.9 percent over the last six months, despite the challenge coming from higher gas prices. Consumers are trading down to private labels and discount retailers, moving from beef to cheaper proteins, or turning to local food banks to supplement groceries. They’re also making trade-offs across time. They are buying used instead of new and choosing to repair rather than replace. They are dropping coverages or opting out of insurance altogether. They are saving less, or even tapping into savings, where they can. They are buying only what they need and managing payments carefully.

Remember that most consumers still have jobs. Unemployment came in at 4.1 percent in October, extending the longest streak in recorded history of U.S. unemployment at or below 4.5 percent. And some workers are turning to gig work to supplement their pay. This continued stability in the job market has supported resilient consumer spending.

The holiday season is widely expected to be strong, but again there is a question about how long consumer strength can last. A roofer recently described the spike in repairs over replacements as “patch and pray,” which captures well the risk faced by a consumer who is effectively borrowing from the future.

The Airport Lounge
You may have noticed that I focused the kitchen discussion on lower-income consumers. That’s because I think of the well-off as sitting in the airport lounge — assuming they can find a seat. They’ve seen remarkable growth in the value of their stocks and their houses in recent years, so they may well be off traveling somewhere.

Wealthy consumers represent a disproportionate share of aggregate spending. Firms catering to these consumers report continued demand. And this segment is less sensitive to price. More than 40 percent of upper-income consumers expect to spend as usual on items that have large price increases in the year ahead. That’s more than double the share of lower-income consumers, according to the University of Michigan Surveys of Consumers.

How long this segment stays on the move is hard to know. Presumably the path forward for asset values will matter.

The FOMC Meeting Room
The decisions made in these three rooms have kept the U.S. economy remarkably stable. With strong earnings, businesses have kept investing and employing amid rising cost pressures, elevated uncertainty, and rapid advancements in AI. With stable jobs and growing wealth, households have kept spending despite flattening real wages and events that once led to pullback, like rising gas prices.

This stability amid such choppy conditions was hard to forecast, to be sure. Many have predicted the low-hire, low-fire equilibrium would have broken by now. Many have predicted an imminent recession. Many have predicted an AI jobs apocalypse. None of these have yet materialized.

What we have seen is stubbornly elevated inflation. Resilient demand paired with broad-based cost increases have put upward pressure on prices. Firms tell us this pressure continues and is leading them to also try to pass on increases that they’ve absorbed to date. They feel they face less resistance to higher prices than they did pre-pandemic, perhaps because a generation of customers and procurement professionals have become accustomed to accepting increases. Should the economy remain on its current path, the risk lies on the inflation side of our dual mandate.

But I am alert to the elephant in the room: What could bring this remarkable resilience to an end? The path of AI feels particularly consequential. If it underdelivers, business investment could pull back, stock prices could follow, and so too could asset-fueled consumer spending. The risk runs the other way, too. AI could overdeliver and displace more workers than expected, resulting in a pullback in spending. Either scenario would move attention to the maximum employment part of our mandate.

In sum, today, with demand healthy and inflation stubbornly elevated, the appropriate direction of monetary policy is relatively straightforward. However, risks to the demand outlook remain easy to envision. Because of that, it is wise to move policy with care.

I feel best prepared for the FOMC meeting room when you’ve helped me understand what’s happening in your corner of the Fifth District. I’ll be glad to learn from your comments and questions.