Jefferson: Disinflation Slows but Economy Remains Solid, No Need to Cut Interest Rates

In mid-January 2026, Federal Reserve Vice Chair Philip N. Jefferson shared his outlook on the U.S. economy for the coming year. In his speech at Florida Atlantic University, he provided a comprehensive analysis of economic growth, labor market dynamics, disinflation challenges, and the central bank’s current monetary policy strategies.

Jefferson emphasized cautious optimism—while the economy remains solidly growing, the pace of job creation has slowed, and disinflation has stalled. This combination gives the Federal Reserve room to keep interest rates at a neutral level without immediate adjustments.

Strong Economic Growth, but Concerns in the Labor Market

Entering 2026, economic data presents a mixed picture. Third-quarter 2025 GDP growth reached 4.3% annually—much faster than the first half of the year. This strength was driven by resilient consumer spending and fluctuating net exports. However, housing investment remains weak, indicating vulnerabilities in certain sectors.

Jefferson projects economic growth will slow to around 2% annually in the coming year, especially considering the impact of federal government disruptions at the end of 2025. Nonetheless, the fundamentals remain solid enough to support continued expansion.

The labor market tells a different story. Non-farm job creation in 2025 showed significant slowdown—adding only about 50,000 jobs per month in November-December, a sharp decline from the previous year. Although unemployment remains relatively low (rising from 4.1% to 4.4%), labor underutilization indicators show weakening trends. The job openings-to-job seekers ratio fell to 0.9 in November—still healthy but well below post-pandemic tightness levels.

Jefferson acknowledged that the risk of job losses has increased, though the baseline projection remains stable unemployment. This weakening partly reflects slower labor force growth due to reduced immigration and participation, but weaker labor demand also plays a significant role.

Disinflation Slowing: Major Hurdle Toward 2% Target

On the other side of the Fed’s dual mandate, more serious challenges emerge. Although inflation has fallen significantly from its mid-2022 peak, disinflation has faced notable obstacles. December 2025 data show the CPI rose 2.7% year-over-year, while Core CPI (excluding food and energy) increased 2.6%—both stable from November but still above the Fed’s 2% target.

Analyzing Core CPI components reveals complex disinflation dynamics. Services inflation (housing rent and other non-energy services) continues to decline sharply, aligning with progress toward the target. However, core goods prices unexpectedly jumped—up 1.4% in December 2025—largely driven by higher import tariffs passed on to consumers.

This slowdown in disinflation complicates policy calculations. Jefferson remains optimistic that tariff effects are one-time shocks—pressing prices temporarily without altering the fundamental downward momentum of inflation. Short-term inflation expectations have fallen from their 2025 peaks, and most long-term expectations remain anchored near 2%. Yet, uncertainty persists.

Rates at Neutral Level: Holding Strategy Reasonable

Given these conditions, the Fed has lowered interest rates by 1.75 percentage points since mid-2024. According to Jefferson, this adjustment has brought the federal funds rate into a range consistent with a neutral stance—neither stimulating nor restraining economic activity.

This position allows the Fed to adopt a wait-and-see approach. In the upcoming policy meeting at the end of January 2026 (just days after this speech), Jefferson implied no further rate adjustments are necessary. The current stance provides flexibility to respond to incoming data and evolving risks in real time, rather than relying solely on forecasts.

“We believe that the current policy stance allows us to make decisions regarding the magnitude and timing of rate adjustments based on upcoming data, ongoing prospects, and risk balance,” Jefferson said, indicating that maintaining the status quo is a reasonable choice for now.

Balance Sheet Management Enters a New Phase: Reserve Management Purchases

The third dimension of the Fed’s strategy involves ongoing balance sheet management. After reducing assets by $2.2 trillion since mid-2022, the Fed began a new phase in December 2025 with reserve management purchases (RMPs).

This development reflects a shift in the supply of bank reserves. As the balance sheet shrinks, bank reserves decline from abundant levels toward an ample threshold—where the Fed commits to operating. With reserves decreasing, the Fed faces challenges in controlling volatile repo and money market rates, especially during tax payments and government bond settlements.

Jefferson emphasized that reserve management purchases are not quantitative easing. QE is a stimulus tool used when interest rates hit the effective lower bound, involving large-scale asset purchases to lower long-term rates. In contrast, RMPs are routine Treasury and short-term security purchases aimed at normalizing the Fed’s asset duration while maintaining reserve supply at ample levels. RMPs help control short-term interest rates without changing the overall monetary policy stance.

Initially, RMPs will be accelerated to ease potential pressures in short-term money markets, then gradually slow as conditions normalize. The final size of the balance sheet will depend entirely on public demand for the Fed’s liabilities within the ample reserve regime.

Additionally, the Fed eliminated the total standing repo facility (SRF) cap in December 2025—serving as a backstop to set a ceiling on money market rates during stress. This move ensures the federal funds rate remains within the target range even under market pressure. Increased use of SRF in late 2025 demonstrated its effectiveness in maintaining orderly market conditions.

Conclusion: Waiting Carefully for Data

Jefferson concluded by reaffirming the Fed’s commitment to its dual mandate: maximum employment and price stability. The U.S. economy enters 2026 in a solid position, with moderate growth and signs of inflation returning toward target, though ongoing disinflation slowdown warrants continued vigilance.

Policy will be proactive in balance sheet management, attentive to labor market risks, and data-driven in future rate decisions. With rates already at a neutral level and non-rate tools optimized, the Fed has done its homework to ensure effective and efficient monetary policy implementation in the year ahead.