Warsh: Inflation has cooled over the past four weeks, AI is reshaping the economy, and forward guidance has lost its necessity.

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Author: Li Jia, Wall Street Insights

On July 1, at the European Central Bank's annual central banking forum in Sintra, Portugal, Walsh clearly stated again that the Federal Reserve will not provide forward guidance on the future interest rate path, hoping that policymakers can engage in full discussions at each FOMC meeting based on the latest data, rather than pre-announcing policy direction to the market.

He said that over the past four weeks, U.S. inflation risks have eased, and the supply expansion driven by AI may profoundly change the way the economy operates. The U.S. is at the center of this transformation, but the central bank should determine whether AI will ultimately lead to inflation or deflation based on data.

Will Not Provide Any Interest Rate Forward Guidance

Walsh said the Fed is "charting a new path" and will not telegraph rate moves in advance as it has in the past. He stated:

"We will have our next meeting in four weeks, and I hope we can have a real family-style debate at that time."

He reiterated that forward guidance is not the right policy for the current economic environment, and the Fed will continue to make decisions based on the latest economic data rather than pre-committing to a policy path to the market.

This means the Fed will rely more on real-time economic data rather than releasing policy signals to the market in advance.

At the June FOMC meeting, the Fed unanimously decided to keep the federal funds rate unchanged in the 3.5%-3.75% range. However, the latest dot plot shows that 9 of 18 officials still expect at least one rate hike this year, and the market has largely priced in at least one 25-basis-point hike by year-end.

However, Walsh himself refused to reveal his policy leanings, only emphasizing that future policy decisions will depend on data.

AI Is Changing the Economy at an Unprecedented Pace

Walsh discussed the impact of artificial intelligence on the macroeconomy at the forum. He noted that the speed of AI model capability improvement is showing clear exponential growth.

He pointed out that the supply expansion driven by AI will become a new variable that monetary policy must focus on, because productivity improvements mean the economy can grow faster with lower inflationary pressure.

However, he also acknowledged that there is still huge uncertainty about how AI will ultimately affect the job market.

"There are serious questions about when AI will actually start to affect employment," he said.

He emphasized that the Fed must continue to achieve both of its statutory goals—maximum employment and price stability—and any policy adjustments need to balance both.

Inflation Risks Have Declined, but Whether AI Has Inflationary Effects Still to Be Seen

Walsh said that U.S. inflation risks have declined over the past four weeks, meaning that recent price pressures have eased to some extent.

However, when it comes to the widely discussed question of whether AI is a deflationary force or a new source of inflation, Walsh did not give a clear answer. He said:

"Whether AI has inflationary effects should be determined by the central bank."

In his view, on one hand, AI can improve production efficiency and expand supply; on the other hand, it may stimulate new investment and demand. Therefore, the final effect must be judged based on data, not predetermined conclusions.

In addition, Walsh pointed out that Fed policy not only affects the U.S. but also has significant spillover effects through global financial markets.

Reaffirming Fed Independence: Policy Will Not Be Affected by External Pressure

Facing ongoing concerns about Fed independence, Walsh again gave a clear response. He said:

"The Fed has long been independent and will remain independent. You will not see any change."

This statement was also seen by the market as a response to U.S. President Donald Trump's recent calls for the Fed to cut rates. Walsh stressed that the Fed will independently determine the appropriate policy path and will not change its decisions due to external political pressure.

The U.S. Is Ushering in a Huge Opportunity for Productivity Gains

Beyond monetary policy, Walsh also focused on the long-term growth outlook for the U.S. economy.

He said that over the past four weeks, he has been focused on monetary policy work, and that this is an era of great opportunity for the U.S. Walsh believes that the supply side of the U.S. economy remains strong, and the potential growth rate appears to be trending upward, so there is good reason to be optimistic about future productivity.

He said that if the economic performance of the past four quarters can serve as a reference for the future, then the U.S. economic outlook is worth being optimistic about. He stated:

"The U.S. is not afraid of productivity-driven economic growth."

However, he also acknowledged that it is unclear whether productivity improvements will have a direct impact on short-term monetary policy, but the continued expansion of supply capacity will undoubtedly profoundly influence future policy making.

Balance Sheet Reduction Stance Unchanged

In addition to interest rate policy, Walsh also discussed the Fed's balance sheet.

He said his views on the balance sheet have not changed over the past four weeks. "It's no secret that I want the Fed's balance sheet to shrink."

However, he also said that the Fed remains open-minded about the eventual size of the balance sheet. Walsh pointed out that balance sheet policy mainly works through asset prices, so any major decisions regarding the balance sheet will be publicly discussed and decided collectively by the FOMC.

He also noted that the current balance sheet size of about $6.7 trillion is still much higher than pre-pandemic levels, and even if the Fed continues to shrink it, the process cannot be completed in a short time. "18 weeks is far from enough."

Five Reform Working Groups Will See New Progress

In fact, abandoning forward guidance is only part of Walsh's push for Fed reform.

Last month, Walsh announced the formation of five internal special working groups, respectively responsible for studying communication mechanisms, the balance sheet, data usage, productivity and employment, and the inflation framework. He most recently disclosed that the list of working group members will be announced as early as next week.

Walsh said that these working groups will not only include internal Fed officials but will also invite external experts, including some international participants from outside the U.S. He hopes that through these reforms, the Fed's policy framework and communication mechanisms will be reexamined, making monetary policy more adaptable to the rapidly changing economic environment.