Thank you, Professor Scobie. Thank you to the European Economics and Financial Centre for inviting me to speak and for the honor of referring to me as a "distinguished speaker." I have noticed that people started calling me "distinguished" only after my hair turned white. I suspect that "distinguished" is a polite way of saying you are old.

My subject today is one I trust is of interest in this center of global finance — namely, the outlook for the U.S. economy and the implications for monetary policy.1 It has been one year and seven months since the Federal Reserve began raising interest rates to rein in inflation, and there has been considerable progress. But uncertainties remain, both about the forces that will shape the economic outlook in the coming months and about whether monetary policy has reached a level that is sufficiently restrictive to support continued progress toward the Federal Open Market Committee's (FOMC) target of 2 percent inflation. Let me share my thinking about what recent economic data can, and in some cases, cannot tell us about the outlook and the appropriate setting for monetary policy.

The data in the past few months has been overwhelmingly positive for both of the FOMC's goals of maximum employment and stable prices. Economic activity and the labor market have been strong, with what looks like growth well above trend and unemployment near a 50-year low. Meanwhile, there has been continued, gradual progress in lowering inflation, and moderation in wage growth. This is great news, and while I tend to be an optimist, things are looking a little too good to be true, so it makes me think that something's gotta give. Either growth moderates, fostering conditions that support continued progress toward our 2 percent inflation objective, or growth doesn't, possibly undermining that progress. But which is going to give—the real side of the economy or the nominal side?

I find myself thinking about two possible scenarios for the economy in the coming months. In the first, the real side of the economy slows. This is the scenario broadly reflected in the September Summary of Economic Projections (SEP) by FOMC participants, where an easing in demand helps bring the economy into better balance with supply and allows inflation to move closer to our 2 percent objective. In this scenario, I believe we can hold the policy rate steady and let the economy evolve in the desired manner.

But I also can't avoid thinking about the second scenario, where demand and economic activity continue at their recent pace, possibly putting persistent upward pressure on inflation and stalling or even reversing progress toward 2 percent. In such a scenario, failing to take action in a timely way carries the considerable risk of undermining what have been fairly stable inflation expectations and possibly unwinding the work that we have done to date. Thus, more action would be needed on the policy rate to ensure that inflation moves back to target and expectations remain anchored.

Before getting into the economic data, let me address the increase in medium- and longer-term interest rates that has occurred since July. The 10-year Treasury yield is up about 90 basis points, while shorter-term maturities increased only a quarter of this amount and primarily early in the period. There are several factors that have been mentioned to explain this movement, including stronger-than-expected incoming data on third quarter economic activity, an increased focus on U.S. deficits and the associated increase in Treasury issuance, as well as geopolitical events and a flight to safety. Whatever the causes, I will be watching how these interest rates evolve in coming months to evaluate their impact on financial conditions and economic activity.

Let's now dig into the recent economic data, starting with those on economic activity that help us get a handle on the strength of demand. Real gross domestic product (GDP) grew at about a 2 percent annual rate in the latter part of 2022 and the first half of 2023. Recent data suggest that this pace stepped up in the third quarter. The latest consensus estimate from the Blue Chip survey of business forecasters was that third-quarter real GDP grew 3.5 percent, and the Atlanta Fed's GDPNow model is coming in even higher. We'll get a first look at the third quarter GDP number next week, but it seems clear that economic activity was substantially higher for July through September than earlier in the year.

The question is whether that acceleration of real activity will be sustained. Sometimes an uptick in activity is followed by some payback, or slowdown. For example, if firms pull construction forward because of good weather, then current structures investment will be high now but lower in the next period. Thus, we want to be careful and not pay too much attention to the specific month activity took place but instead average growth over a couple of quarters to get a clearer picture of the underlying strength of the economy.

To see this point more clearly, recall that at the start of this year, personal consumption expenditures increased dramatically in the first quarter but subsequently grew less rapidly in Q2 of 2023. A similar dynamic may be playing out now. On the other hand, if the third quarter data represents the beginning of persistently stronger demand, then we can expect that strength to show up in the fourth-quarter data, including by putting upward pressure on prices, which could have ramifications for upcoming decisions on monetary policy.

In thinking about these two possibilities, let me tell you how I view two key components of GDP growth this year.