Summary
Monetary Policy Report submitted to the Congress on July 10, 2026, pursuant to section 2B of the Federal Reserve Act
Inflation has risen this year and remains elevated relative to the Federal Open Market Committee's (FOMC) longer-run objective of 2 percent, in part reflecting supply shocks that have driven price increases in certain sectors, including energy. The labor market has been broadly stable, with the unemployment rate changing little and remaining at a low level. Labor productivity growth is strong. Meanwhile, real gross domestic product (GDP) grew at a moderate pace in the first quarter, with capital investment rising considerably but household consumption increasing only very modestly. Overall, economic activity is expanding at a solid pace despite elevated uncertainty that owes, in part, to the conflict in the Middle East.
Against this backdrop and in support of the Federal Reserve's dual mandate, the FOMC has maintained the target range for the federal funds rate at 3-1/2 to 3-3/4 percent since the beginning of the year. At the June FOMC meeting, the Committee emphasized its commitment to delivering price stability.
Regarding the Federal Reserve's balance sheet, at the December 2025 meeting, the FOMC judged that reserve balances had declined to ample reserve levels and initiated the purchases of shorter-term Treasury securities as needed to maintain an ample supply of reserves on an ongoing basis. At the June meeting, the Committee reaffirmed its policy of maintaining ample reserves in the banking system.
Over the remainder of the year, independent task forces led by the very best minds from inside and outside of the economics profession, supported by key subject-matter professionals within the Federal Reserve, will examine five areas that are central to the Federal Reserve's conduct of monetary policy: (1) communications, (2) balance sheet policy, (3) the quality of existing data sources, (4) productivity and jobs in an era of transformation, and (5) frameworks for analyzing the drivers of inflation. Each task force will start with first principles, ask hard questions, examine current practice, consider alternatives, and, ultimately, propose next steps for the Federal Reserve's consideration.
Recent Economic and Financial Developments
Inflation. Measures of consumer price changes began trending up last year and then stepped up further this spring. Over the 12 months ending in May, the price index for total personal consumption expenditures (PCE) rose 4.1 percent. Core PCE prices—which exclude often-volatile food and energy prices and are generally considered a better guide to future inflation developments—rose 3.4 percent. Both measures were notably above their year-earlier readings. Among the factors contributing to higher measured prices are earlier tariff hikes that pushed up domestic prices of some imported goods, a surge in energy prices associated with constraints on oil supplies following the start of the Middle East conflict in late February, and increased demand for some high-tech products that support artificial intelligence (AI) applications. Some measures of shorter-term inflation expectations moved higher following the jump in energy prices earlier this year. By contrast, most measures of longer-term inflation expectations have remained within the range of values observed over the decade before the pandemic and continue to be broadly consistent with the FOMC's longer-run objective of 2 percent inflation.
The labor market. Following a period of cooling, the labor market has stabilized, with demand and supply roughly in balance. The unemployment rate, at 4.2 percent in June, was low and has been little changed since last summer. Layoffs have been subdued and job vacancies have been roughly flat, on balance, this year, though private payroll gains have picked up. A marked slowdown in immigration and ongoing declines in labor force participation due to the aging of the population led to a slowdown in labor supply growth. Finally, solid nominal wage growth has been accompanied by strong growth in labor productivity.
Economic activity. In the first quarter, real GDP moved up at a moderate annual rate of 2.1 percent, similar to last year's pace. The gains in the first quarter were supported by robust growth in high-tech business investment and a bounceback in federal purchases following the government shutdown in the fourth quarter of last year. Through the first five months of this year, household consumption rose at a modest average annualized rate of 1.3 percent. Activity in the housing market has remained stagnant, with both sales of existing homes and construction of new single-family homes little changed so far this year. In the manufacturing sector, output has moved up strongly this year, partly reflecting increased demand for goods related to the buildout of data centers supporting AI services. The economy's productive capacity appears to be rising at a solid pace as historically subdued growth in the labor force has been offset by strong growth in labor productivity.
Financial conditions. Since the start of the year, Treasury yields have risen and the market-implied expected path of the federal funds rate has moved up. The largest increases in Treasury yields occurred at shorter maturities, as market expectations of a higher federal funds rate path pushed up real interest rates. This revised assessment by market participants of expected monetary policy appeared to reflect both the effects of the Middle East conflict on inflation and increased confidence in the stability of the labor market. Broad equity price indexes moved up, while yields on corporate bonds rose moderately. Credit remained broadly available to most nonfinancial firms, households, and municipalities, although small businesses and households continued to face relatively tight credit conditions. Bank lending grew in the first half of 2026, likely reflecting easier lending standards and stronger demand.
In the modern economy, it is difficult to measure the stock of money. One of a number of series traditionally used to provide an empirical approximation to the stock of money is the M2 monetary aggregate. Over the first five months of the year, 12-month rates of increase in M2 were moderate and broadly similar to the pace typically observed during the 2010s.
Financial stability. Overall, the U.S. financial system remained sound and resilient, with vulnerabilities roughly unchanged, on net, since the beginning of the year. Asset valuations remain above historical norms across equity, corporate debt, and residential real estate markets. Total debt of nonfinancial businesses and households as a fraction of GDP continued to edge down over the first half of 2026 and currently stands at its lowest level since the early 2000s. Leverage of hedge funds and the largest life insurers remained elevated relative to historical standards. Risk-based regulatory capital levels at banks stayed high compared with the past few decades, and bank capital positions became less sensitive to increases in long-term yields. Assessments of vulnerabilities stemming from funding risks are consistent with historical norms across most sectors of the financial system. Some private credit vehicles faced notable increases in redemption requests in the first quarter of 2026, reflecting some defaults and concerns about the quality of underlying assets. In most cases, the managers of these funds imposed limits on redemptions, and private credit markets continued to function normally. (See the box "Developments Related to Financial Stability.")
International developments. Growth in foreign economic activity was subdued overall in the first half of 2026, in part reflecting headwinds generated by the Middle East conflict and U.S. tariffs. However, these headwinds were partially offset by the surge in AI-related investment. Foreign headline inflation has increased notably in recent months in response to the sharp rise in prices of energy and other related commodities during the conflict. Foreign producer prices have also risen, possibly posing additional inflationary risks abroad. In response, several foreign central banks raised their policy rates, and others shifted their communications to emphasize their commitment to price stability, despite weaker growth prospects. Equity prices abroad rose even as foreign sovereign bond yields increased. The trade-weighted exchange value of the U.S. dollar has appreciated modestly, on net, since the start of this year, remaining strong in real terms relative to its historical average.
Monetary Policy
Interest rate policy. In support of the Federal Reserve's dual mandate, the FOMC has maintained the target range for the federal funds rate at 3-1/2 to 3-3/4 percent since the beginning of the year. The Committee has noted that economic activity is expanding at a solid pace despite elevated uncertainty that owes, in part, to the conflict in the Middle East; productivity growth and capital investment are strong; job gains have kept pace with the workforce; and the unemployment rate has changed little. Inflation remains elevated relative to the Committee's 2 percent goal, in part reflecting supply shocks that have driven price increases in certain sectors, including energy. The Committee will deliver price stability.
Balance sheet policy. At the December 2025 meeting, the FOMC judged that reserve balances had declined to ample reserve levels and initiated purchases of shorter-term Treasury securities to maintain an ample supply of reserves on an ongoing basis. At the June meeting, the Committee reaffirmed its policy of maintaining ample reserves in the banking system.
Special Topics
Employment and earnings across groups. Employment disparities across sex, race, ethnicity, and education continue to be relatively narrow compared with historical levels. Nevertheless, significant disparities in absolute levels remain. Additionally, the robust real wage gains experienced by some historically disadvantaged groups in recent years have since moderated as labor market tightness has eased and consumer price inflation has remained elevated. (See the box "Employment and Earnings across Demographic Groups.")
Federal Reserve's balance sheet and money markets. The FOMC continued reserve management purchases to maintain an ample supply of reserves. Usage of the overnight reverse repurchase agreement facility remained near zero on most days, and standing repurchase agreement operations were tapped when economically sensible. Overnight money markets were stable. (See the box "Developments in the Federal Reserve's Balance Sheet and Money Markets.")
Monetary policy rules. Policymakers routinely consult information derived from the analysis of simple monetary policy rules. However, existing rules cannot capture all of the considerations that go into the formation of appropriate monetary policy; nevertheless, some principles of effective monetary policy can be understood by examining the current policy implications of these rules. (See the box "Monetary Policy Rules in the Current Environment.")