Federal Reserve Monetary Policy Report: Inflation has increased significantly, and AI “pushes up prices and supports growth”
On Friday local time, the Federal Reserve released its semi-annual Monetary Policy Report. This is also the report that new Federal Reserve Chairman Kevin Warsh will receive at a congressional hearing next week. It should be noted that due to the legal battle between Trump and former Federal Reserve Chairman Jerome Powell at the beginning of the year, the hearing this spring could not be held. Therefore, the last time the Federal Reserve released its "semi-annual" monetary policy report was in June last year. In this neither long nor short year, the economic outlook and monetary policy of the United States have undergone tremendous changes.
On Friday local time, the Federal Reserve released its semi-annual Monetary Policy Report. This is also the report that new Federal Reserve Chairman Kevin Warsh will receive at a congressional hearing next week. It should be noted that due to the legal battle between Trump and former Federal Reserve Chairman Jerome Powell at the beginning of the year, the hearing this spring could not be held. Therefore, the last time the Federal Reserve released its "semi-annual" monetary policy report was in June last year. In this neither long nor short year, the economic outlook and monetary policy of the United States have undergone tremendous changes. As the basis for triggering a series of policy changes, U.S. inflation is at a critical point of clearly picking up again. Compared with the June 2025 report that said "inflation continues to slow down," the July 2026 report has changed to say that "inflation has been heating up since the end of last year and jumped further in March this year." PCE, the inflation measure focused on by the Fed, surged by 1.6 percentage points in a year, from 2.5% to 4.1%, and core PCE excluding food and energy also rose from 2.8% to 3.4%. (Changes in US PCE data in the past year, source: tradingeconomics) Well-known Fed observer Nick Timilaus also pointed out on social media that the chart in the report comparing the current policy rate with various policy rules shows that the policy rate is basically in line with the recommendations of these rules in 2024-25, but appeared to be slightly lower earlier this year. The Fed also referred to "another way of looking at inflation" in its report. By excluding "some of the effects of abnormal price movements," the censored average annual PCE inflation rate compiled by the Dallas Fed fell from 2.6% in May last year to 2.4% in May this year. Interestingly, the Fed official who wrote the report also added an additional note on the indicator: "The trimmed average inflation indicator is usually a better predictor of future overall inflation trends than the core PCE, but it may also give misleading signals when the distribution structure of price changes changes. During the surge in inflation in 2021, the slow response of this indicator may be related to this limitation." Warsh has previously said policymakers need to look at inflation measures from a broader perspective to more accurately capture price pressures. His "first priority" after taking office was to form five working groups controlled by external experts, one of which was responsible for studying whether there were problems with the Fed's system for measuring inflation. As a potential tone for next week's hearing, the Fed's latest report mentioned "price stability" 14 times and emphasized that "the Committee is prepared to take vigorous measures to ensure that long-term inflation expectations remain stable." In the report for the same period last year, "price stability" appeared only five times. Like the latest interest rate resolution, the latest report deleted the words "waiting for more clear information" and "the magnitude and timing of future (interest rate) adjustments" and changed it to a very direct statement: “The Committee will deliver price stability.” "The Commission will achieve price stability." In addition, as a result of the review of the 2025 monetary policy framework, the long-term monetary policy strategy statement attached to the beginning of the latest report has also undergone significant changes, deleting "average inflation target", "compensatory overshoot" and other words that caused the Fed to act slowly. AI has become a “source of inflation” and a “pillar of investment growth” In last year's report, the Fed concluded that the main factor affecting inflation was simply "the early impact of tariff policy." A year later, the Federal Reserve pointed out that the price transmission of previously imposed tariffs, energy increases caused by conflicts in the Middle East, and demand for AI-related high-tech products are jointly pushing up inflation. That point is expected to be a focus of next week's hearing. Warsh had earlier said artificial intelligence would boost productivity, which would help lower inflation. When attending the ECB Sintra Forum last week, Warsh still insisted that AI will eventually reduce inflation by increasing productivity and expanding supply, but he also admitted that the current AI infrastructure construction is pushing up the demand (and prices) for inputs such as chips and electricity. It is difficult to judge when the productivity dividend will be fully realized. Of course, AI is not only the three major sources of US inflation, but also a pillar supporting US economic growth.
Compared with last year's report, which only listed AI as "a supporting factor for capital expenditures," the latest report has listed AI as the leading factor explaining the growth of U.S. corporate investment. The report writes that corporate fixed investment will grow strongly at an annualized rate of 11% in the first quarter of 2026, and much of this strong performance appears to be related to building the infrastructure required for AI services. The report also specifically pointed out that after excluding AI-related categories, investment in other areas was generally weak. In other words, the U.S. economy is not experiencing a comprehensive capital spending boom, but is experiencing a "single point explosion" led by AI. Federal Reserve system's "profitability" improves The Fed's balance sheet policy has also undergone a transformation in the past year. In June last year, the Fed continued to reduce its holdings of Treasury bonds and mortgage-backed securities; in this year's report, the Fed confirmed that as bank reserves fell to "adequate" levels, it had begun purchasing short-term U.S. Treasury bonds to continue to maintain the supply of reserves in the banking system. This operation belongs to "reserve management purchases", and its main purpose is to ensure the smooth operation of the money market, not to stimulate the economy by lowering long-term interest rates, so it cannot be simply understood as restarting quantitative easing. From an operational perspective, the Federal Reserve has ended its continuous balance sheet reduction and entered a technical bond-buying phase aimed at maintaining sufficient reserves, and the balance sheet has also recovered slightly as a result. The Federal Reserve System's "profitability profile" has also improved this year. After continuing to post net losses since the second half of 2022, the Fed reported that its consolidated deferred assets (that is, the accumulated losses that need to be covered by net income before resuming future profit remittances to the Treasury) have fallen by $7 billion since early January this year to about $236 billion. The report also stated that some regional Feds that have exhausted their own deferred assets have remitted a total of approximately $6 billion to the U.S. Treasury this year. The New York Fed projected earlier this year that the Fed system's overall net income is expected to return to positive levels in 2026. (
Compared with last year's report, which only listed AI as "a supporting factor for capital expenditures," the latest report has listed AI as the leading factor explaining the growth of U.S. corporate investment. The report writes that corporate fixed investment will grow strongly at an annualized rate of 11% in the first quarter of 2026, and much of this strong performance appears to be related to building the infrastructure required for AI services. The report also specifically pointed out that after excluding AI-related categories, investment in other areas was generally weak. In other words, the U.S. economy is not experiencing a comprehensive capital spending boom, but is experiencing a "single point explosion" led by AI. Federal Reserve system's "profitability" improves The Fed's balance sheet policy has also undergone a transformation in the past year. In June last year, the Fed continued to reduce its holdings of Treasury bonds and mortgage-backed securities; in this year's report, the Fed confirmed that as bank reserves fell to "adequate" levels, it had begun purchasing short-term U.S. Treasury bonds to continue to maintain the supply of reserves in the banking system. This operation belongs to "reserve management purchases", and its main purpose is to ensure the smooth operation of the money market, not to stimulate the economy by lowering long-term interest rates, so it cannot be simply understood as restarting quantitative easing. From an operational perspective, the Federal Reserve has ended its continuous balance sheet reduction and entered a technical bond-buying phase aimed at maintaining sufficient reserves, and the balance sheet has also recovered slightly as a result. The Federal Reserve System's "profitability profile" has also improved this year. After continuing to post net losses since the second half of 2022, the Fed reported that its consolidated deferred assets (that is, the accumulated losses that need to be covered by net income before resuming future profit remittances to the Treasury) have fallen by $7 billion since early January this year to about $236 billion. The report also stated that some regional Feds that have exhausted their own deferred assets have remitted a total of approximately $6 billion to the U.S. Treasury this year. The New York Fed projected earlier this year that the Fed system's overall net income is expected to return to positive levels in 2026. (