Jefferson Explains the Disinflation Process and Economic Outlook for Early 2026

Vice Chair of the Federal Reserve Philip N. Jefferson delivered an in-depth view on the economic outlook and the ongoing disinflation process during a speech at Florida Atlantic University in January 2026. With an optimistic yet cautious tone, Jefferson emphasized that the economy is on a good path to continue growing as the disinflation process toward the 2% inflation target progresses, despite facing some challenges.

Economic Growth Remains Solid Despite Technical Hurdles

Jefferson’s remarks began with positive notes on the U.S. economic conditions in early 2026. In Q3 2025, GDP growth reached 4.3% annually, significantly above the pace in the first half of the year. This performance was mainly driven by strong consumer spending and a rebound in net exports. Business investment showed steady growth, although residential investment still contributed little.

Despite healthy growth, the economy experienced technical setbacks in Q4 2025 due to government shutdown impacts. Nonetheless, Jefferson projects that the economy will grow at a steady rate of around 2% in the near term, reflecting its solid fundamentals.

Labor Market Shows Signs of Slowing

The labor market condition is an area requiring closer attention, according to Jefferson. Job growth in 2025 slowed compared to the previous year. In November and December 2025, employers added only about 50,000 non-farm jobs per month—far below historical trends.

The unemployment rate at the end of 2025 was 4.4%, slightly higher than 4.1% at the end of 2024. This slowdown partly reflects a deceleration in labor force growth due to immigration factors and declining labor force participation. However, labor demand also weakened, with the job openings-to-unemployment ratio dropping to 0.9 in November 2025, much lower than during the post-pandemic recovery period, indicating a less dynamic labor market. Jefferson acknowledged that the risk of job losses has increased, though the baseline projection remains that unemployment will stay stable throughout the year.

Slow Decline in Inflation: Price Pressures in Goods Offset Service Price Drops

The most complex aspect of Jefferson’s analysis is the dynamics of the ongoing disinflation process. Recent data show that consumer inflation (CPI) in December 2025 rose 2.7% year-over-year—unchanged from November—while core inflation remained at 2.6%. Although both indicators have fallen sharply from their mid-2022 peaks, the disinflation process has slowed considerably over the past year.

Analyzing components of the Core CPI offers key insights into the complexity of current disinflation. Service inflation—especially housing rents and other non-energy services—continues to decline significantly, aligning with the return toward the 2% target. However, this decline in services is offset by a surge in core goods prices.

After spiking during the pandemic, goods inflation fell sharply to pre-pandemic levels by 2023. But in 2025, the disinflation dynamic shifted as core goods inflation rose notably, reaching 1.4% annually in December 2025. Jefferson admits that this increase is at least partly due to higher import tariffs transmitted into consumer prices.

Nevertheless, Jefferson remains optimistic that disinflation will continue toward the 2% target. The baseline scenario is that tariff impacts on inflation are one-time effects on price levels, not permanent changes in inflation trends. With short-term inflation expectations indicators declining from their peaks last year, and most long-term expectations remaining aligned with the 2% target, the foundation for sustained disinflation remains solid.

Risk Balance Supports Status Quo in Interest Rate Policy

Regarding monetary policy implications, Jefferson explained that rising risks of job losses last year shifted the Federal Reserve’s risk assessment. In response, the Federal Open Market Committee (FOMC) has cut the policy rate by 1.75 basis points since mid-2024. These measures, Jefferson states, have brought the federal funds rate into a range consistent with a neutral rate—neither stimulating nor restraining economic activity.

In the current context, Jefferson signaled clearly that no further adjustments are needed at upcoming policy meetings in the near future. The current policy stance allows the Fed to make decisions on the pace and timing of adjustments based on incoming data, evolving outlooks, and a dynamic risk assessment.

Balance Sheet Management and Repo Operations: Technical Steps for Market Stability

Jefferson then shifted focus to technical aspects of monetary policy implementation. Since January 2019, the Fed has operated under a reserve adequacy framework, defining operations as controlling the federal funds rate through setting the policy rate without actively managing reserve supply. The main advantage of this framework is its success in controlling the policy rate across various economic conditions.

By December 2025, the Fed completed the balance sheet runoff begun in mid-2022, reducing securities holdings by about $2.2 trillion. As the balance sheet shrank, bank reserves declined from abundant levels of around $3.5 trillion to a more adequate level. This created new dynamics in the money markets, with repo rates showing increased volatility, especially during large tax payment days.

Recognizing these dynamics, the Fed began reserve management purchases (RMP) in December 2025—an important technical tool to maintain adequate reserve levels and ensure effective interest rate control. It’s important to note that RMP is not quantitative easing (QE). QE is a stimulus tool used when the policy rate hits the effective lower bound, primarily to lower long-term interest rates. In contrast, RMP involves purchasing short-term Treasury securities to maintain the average duration of the Fed’s holdings, supporting short-term interest rate policy without altering broader financial conditions.

Jefferson explained that RMP will be accelerated in the first few months to ease potential short-term pressures in the money markets, then scaled back according to reserve demand. The ultimate size of the Fed’s balance sheet will be determined by public demand for its liabilities within the reserve adequacy regime.

Additionally, standing repo operations (SRO) play a key role as a tool to set a ceiling on short-term interest rates. As of December 2025, the Fed eliminated the total cap on SROs, allowing more flexible use as needed. This proved effective at the end of 2025 when large Treasury settlements caused significant upward pressure on repo rates, prompting increased use of SROs to maintain stability.

Outlook: Optimistic but Cautious

In conclusion, Jefferson reaffirmed his optimistic yet cautious stance on the economic outlook. Acknowledging risks to both sides of the Fed’s dual mandate—maximum employment and price stability—he committed to closely monitoring upcoming data. Although the disinflation process is slowing, it remains on track toward the 2% target, especially assuming tariff effects are temporary.

The Fed’s ability to implement monetary policy decisions efficiently and smoothly is crucial for achieving its mandate. Technical measures like RMP and SROs are well-positioned to support this goal. Through careful data analysis, dynamic risk assessment, and flexible operational tools, Jefferson demonstrated that the Federal Reserve is prepared to navigate the complexities of the economy and the challenges of disinflation in the coming years.