Monetary Policy Mistakes

Monetary policy mistakes are often self-inflicted. Sometimes, policymakers cling to an official policy for too long, necessitating a swift and sharp reversal to mitigate economic harm. At other times, they try to address or reduce economic imbalances that aren't caused by monetary policy. That's when policy mistakes happen, and it seems that policymakers are about to make another mistake soon if they react to recent job data. Policymakers are tasked with an employment and inflation mandate, yet they are not mandated to correct or counteract the "stupidity" or "misguided" decisions of fiscal policy.

Several policymakers have publicly expressed concern that the weakness in labor markets, particularly the sharp slowdown in job growth, justifies another official rate cut at the upcoming FOMC meeting in December. However, before deciding to change its monetary policy stance, policymakers should investigate whether the weakness in the job market is connected to their official interest rate stance or to other factors beyond their control, which could result in a policy mistake.

For the week ending November 22, jobless claims fell to 216,000, the lowest level since April. The long history of jobless claims shows that this weekly indicator is a reliable leading indicator of labor market activity. This low number of claims suggests that the limited job creation is not due to weak business activity or restrictive monetary policy. If that were the case, jobless claims would be much higher, possibly double.

Small businesses, which are responsible for most of the new job creation, have experienced negative job growth throughout most of 2025. A major factor contributing to this is the uncertainty and increased costs associated with Trump's tariff policy. The increasing "cost of doing" business and the uncertainty about whether tariffs will rise or be eliminated ultimately pose substantial challenges for small businesses with thin profit margins.

The retail trade sector, one of the largest private employers and primarily consisting of small businesses, has been both directly and indirectly affected by tariffs on imported goods. This sector has seen nearly 100,000 job cuts in the first nine months of 2025. Tariff-related?

Since the tariff policy was announced in April, the unemployment rate, which is one part of the Fed's dual mandate, has risen from 4.2% to 4.4%, a relatively small increase. In response to this slight rise, the Fed has reduced overall official rates twice, totaling 50 basis points.

However, Trump's tariff policy has a more direct effect on inflation, which is the other half of the Fed's dual mandate. Since April, CPI inflation has increased to 3%, up from the 2.3% rate that existed before the tariff announcement. The Fed targets a 2% inflation rate, and despite current inflation rising considerably above this target since tariffs were introduced, policymakers have not considered changing their policy approach to tackle the increase.

If businesses are reluctant to hire due to the tariff policy under Trump's administration and inflation is moving higher due to the imposition of tariffs, and further away from the Fed's target, why should monetary policy address one part of its mandate, which is unrelated to its official rate stance, while ignoring the second part of its mandate? A dual mandate is effective only when policymakers address both sides equally.

A growing number of the current generation of Fed policymakers appear to be considerably more political in their approach to monetary policy, disregarding data and their mandates. According to public statements, this group of policymakers intends to vote for another official rate in December, despite job and price data suggesting that another rate cut is unnecessary.

The political dynamics of the Fed are likely to become more divided as President Trump is set to announce a new chair to succeed Fed Chair Powell in May 2026. A policy error in December 2025 might quickly lead to additional mistakes in 2026, making bond yields and the dollar more volatile and unpredictable factors for investors.