Philadelphia Federal Reserve President Anna Paulson presented a “benign” baseline forecast for the U.S. economy in a speech delivered Saturday, predicting that inflation will continue to moderate and the labor market will stabilize in 2026, despite recent data showing a sharp divergence between gross domestic product growth and a cooling labor market.
Paulson highlighted the difficulty in distinguishing between cyclical slowdowns and structural shifts driven by artificial intelligence and deregulation. She drew parallels to the productivity boom of the late 1990s, suggesting that the current policy stance may need to remain flexible to avoid stifling a supply-side expansion.
“Monetary policy can offset a cyclical slowdown in demand, but it can’t do anything about a structural change in the demand for labor,” she noted, referencing the uncertainties and warning signs around generative AI’s impact on the labor market.
She referenced a report from researchers affiliated with Stanford University that found a 13% relative decline in employment among early-career workers (ages 22 to 25) in the careers most exposed to AI — a warning sign that might be masked by the overall jobs data.
Paulson noted that nearly 90% of net private job creation through November 2025 occurred in one sector: health care and social assistance. And only larger firms — those with 250 employees or more — tended to add workers; small businesses were more likely to cut their workforce.
Paulson’s remarks come after the Federal Open Market Committee cut interest rates by 75 basis points in 2025. With personal consumption expenditures (PCE) inflation ticking up to 2.8% annually in September and unemployment reaching 4.6% in November — its highest level in four years — policymakers are weighing the impact of new tariffs and a decline in immigration against the potential for an AI-led productivity surge.
Paulson characterized her inflation outlook as “cautious optimism,” noting that while goods inflation has risen due to tariffs, housing inflation has dropped significantly from 5.1% to 3.7% over the last year.
The central tension in Paulson’s analysis is the “divergent signals” between output and employment. Third-quarter real GDP growth hit an “above-trend” 4.3%, yet payroll growth has narrowed, and nearly 90% of private job creation was centered in health care and social assistance. Paulson attributed the labor deceleration to both a sharp drop in immigration on the supply side and uncertainty regarding trade policy and AI on the demand side.
Looking ahead, Paulson signaled that “modest further adjustments” to the federal funds rate could be appropriate later in the year if her baseline forecasts holds. She views the current rate as “still a little restrictive,” which she argues will help guide inflation down toward the Fed’s 2% target.
However, she stressed the importance of credibility and patience, citing former New York Fed President William McDonough’s 1997 advice that credibility comes from “doing the right thing” rather than reflexively raising rates.
Such a warning comes at a time when the Fed’s independence — and the accuracy of government-supplied data — is in question.
