The September 16 FOMC Decision:
Confirmation of the Warsh Reaction Function, the Lucas Supply-Curve Problem, and the Unresolved Path Ahead
An Updated Assessment as of September 16, 2026
Farid Novin
I. From Bayesian Corridor to Realized Outcome
The September 9 assessment left the Federal Open Market Committee's September decision genuinely undetermined, assigning approximately 55 to 60 percent probability to a 25-basis-point increase, with the balance of probability split between a hawkish hold and, at much lower weight, a dovish hold. That assessment identified the August Consumer Price Index and Producer Price Index releases of September 10 and 11 as the pivotal observations that would resolve the Bayesian corridor one way or the other. The Committee's decision on September 16 has now resolved that corridor. The Federal Open Market Committee raised the federal funds target range by 25 basis points, to 3.75 to 4.00 percent, in a unanimous vote of all twelve members. This was the first increase in the policy rate since July 2023.
A modal outcome being realized is analytically satisfying but not, by itself, the end of the inquiry. Two questions now take priority over the question this report previously treated as central. First, what does the manner of the decision — a unanimous vote, retained "timelier return" language, and a Summary of Economic Projections tilted toward further tightening — reveal about the underlying state of the Committee's beliefs, as distinct from the beliefs that produced the July split. Second, and more analytically demanding, what does the decision imply about the economy's near-term trajectory once it is interpreted through a formal aggregate-supply, aggregate-demand lens rather than through probability language alone. This update addresses both, and closes by identifying what would need to be observed over the next reporting cycle to determine which of the two competing narratives about the decision's ultimate effect is correct.
II. The Decision and What the Vote Reveals
The unanimity of the September vote is, on its own terms, the single most informative fact to emerge from the meeting. The July meeting had produced a three-member hawkish dissent, with Beth Hammack, Neel Kashkari and Lorie Logan preferring an increase against a majority that held rates steady. A simple extrapolation from that split would have predicted a divided September vote as well, with the hawkish minority prevailing only if it could attract additional support. Instead, the vote was twelve to zero. Every participant who might have preferred to wait converged, within seven weeks, on the same conclusion as the July hawks.
This is precisely the pattern the prior report's signaling-game framework anticipated as the strongest evidence of a genuine Bayesian update rather than a mechanical or politically motivated decision. A chairman who reveals a reaction function at a symposium and then delivers an outcome consistent with that reaction function, while simultaneously bringing a previously divided committee to unanimity, has demonstrated that the revealed preference was substantive rather than rhetorical. The alternative reading — that unanimity was manufactured through institutional pressure on dissenters — finds little support in the record; the Summary of Economic Projections itself shows a still-divided Committee on the pace of further adjustment, with some participants continuing to favor a half-point cumulative move this year and a residual few still projecting a cut before year-end. Unanimity therefore describes agreement on the September action specifically, not agreement on the reaction function going forward. The doves converged on the diagnosis that some tightening was warranted now; they did not converge on how much tightening is warranted in total.
III. Inside the Reaction Function: Reading the Press Conference
Chairman Warsh's post-meeting remarks are best read as a direct continuation of the Jackson Hole framework rather than as new doctrine. Asked to explain what had changed since the Committee's prior meeting seven weeks earlier, he identified three factors: a strengthening in the underlying assessment of economic activity, an inflation trend that had not passed the test he had described at Jackson Hole of interrogating reality rather than reacting to isolated data points, and a shift in the Committee's judgment about which geopolitical scenarios were most and least likely. Each of these maps directly onto a variable this report's framework has tracked since August: labor-market resilience, the persistence of core and headline inflation, and the Strait of Hormuz and Bab-el-Mandeb disruptions.
Two aspects of the press conference deserve particular emphasis because they complicate rather than simplify the analysis. First, Warsh explicitly declined to characterize the new policy stance as restrictive, saying he and his colleagues remained hard-pressed to describe financial conditions that way even after removing what he called a dose of accommodation. This is analytically significant: a central bank that has just tightened policy but still will not call the resulting stance restrictive is signaling that it does not believe the September move, by itself, is sufficient to complete the disinflation process. Second, when pressed on the neutral rate of interest, Warsh declined to assign it any operational role in the Committee's decision-making, describing it as an academic construct of continuing interest to him personally but not a variable the Committee uses to calibrate current policy. Taken together, these two positions suggest a Committee that is navigating by inflation and employment outcomes directly rather than by any implicit distance-from-neutral calculation — a stance consistent with the anti-mechanical, trends-not-data-points doctrine Warsh has articulated since Jackson Hole, but one that leaves an outside observer with less visibility into how much further tightening the Committee believes is required to reach a genuinely restrictive stance.
A third exchange, with a reporter recalling Warsh's earlier warning that the Federal Reserve was at risk of making a sixth or seventh consecutive policy mistake by judging the economy too strong to justify lower rates, is worth flagging on its own terms. Warsh's response — that the intervening data, broadly defined, now shows the economy has indeed strengthened — is a textbook instance of legitimate Bayesian updating rather than inconsistency. A policymaker whose priors shift as new information arrives is behaving exactly as the framework in this report's prior installment argued a credible central banker should. The material fact is not that his assessment changed; it is that it changed in the same direction as the data that arrived in the interim, which is the hallmark of a functioning reaction function rather than a predetermined one.
IV. An Aggregate Supply–Aggregate Demand Interpretation of the Decision
The analytical structure proposed for this update treats the Committee's problem as one of locating an equilibrium among three curves rather than as a single-dimensional choice between raising and holding. A long-run supply relationship, anchored to the economy's potential output and to the Committee's own judgment about full employment, is treated as vertical: it defines the output level the economy can sustain without generating an accelerating inflation process, independent of the price level. Warsh's repeated insistence, both at Jackson Hole and again in the September press conference, that the labor market is running consistent with full employment functions as exactly this kind of anchor. It tells the Committee where the long-run curve sits.
A separate, short-run relationship between the price level and output — upward sloping, reflecting the fact that firms and workers respond partially and gradually to cost pressures — has been pushed upward by the intensifying disruption in the Strait of Hormuz and the Bab-el-Mandeb Strait. Brent crude above 100 dollars a barrel, and the associated rise in gasoline and diesel costs, raises marginal production and transport costs economy-wide. Warsh's own explanation of why long-term yields have risen — citing, among other things, the difference between spot energy prices and the so-called crack spreads that determine what consumers actually pay at the pump and in shipped goods — is itself evidence that this short-run cost-push channel is operating, independent of any change in the economy's underlying productive capacity.
Where the long-run and short-run relationships intersect defines a higher rate of inflation than would prevail absent the energy shock, at the same level of potential output. If the economy is assumed to be at a general equilibrium, aggregate demand must also pass through that same point; this is the assumption underlying the claim that a rate increase, by raising the cost of borrowing and compressing consumption, investment and net exports, pulls the aggregate demand relationship downward and to the left. The new intersection of a lower aggregate demand curve with an unchanged short-run supply curve occurs at a lower rate of inflation, but at a level of output below potential. This is the central analytical claim worth stating plainly: a rate increase, under this framework, lowers inflation not by reversing the supply shock but by opening an output gap. The short-run curve itself — the relationship that embodies the cost-push effect of the Hormuz and Bab-el-Mandeb disruptions — has not moved. It has simply been approached from a different, demand-suppressed point.
The consequence that follows, on this framework, is that the disinflation purchased in September is rented rather than owned. An output gap of the kind implied by a leftward shift in aggregate demand cannot be sustained indefinitely without generating exactly the labor-market deterioration Warsh has said the Committee does not intend to produce. If the underlying supply disturbance persists — that is, if shipping and energy flows through the two straits remain impaired — then relieving the output gap through subsequent easing would allow inflation to drift back toward the higher, supply-shock-determined intersection, because nothing in the interim would have moved the short-run curve itself. On this reading, the logic that produced Wednesday's increase points, in the absence of a resolution to the Hormuz and Bab-el-Mandeb disruptions, toward an eventual reversal rather than a continued tightening cycle: the Committee would eventually need to ease, most plausibly by an amount comparable to the increase just delivered, once the costs of a below-potential economy become apparent in the data, even though doing so would not by itself have solved the original inflation problem.
This conclusion is not the only defensible reading of the same facts, and it is worth stating the strongest counterargument on its own terms rather than dismissing it. An alternative, expectations-centered channel holds that a credible rate increase can shift the short-run relationship itself, rather than merely moving the economy along an unchanged one. If households, firms and wage-setters treat the September increase as convincing evidence that the Committee will not tolerate a persistently higher inflation rate, they may build a lower expected inflation rate into contracts, wage demands and pricing decisions, which would show up as a downward shift in the short-run curve over time, independent of any output loss. This is close to the argument implicit in the July minutes' observation that inflation compensation had moved only marginally despite the earlier run-up in oil prices, and it is the strongest theoretical basis for Governor Warsh's greater willingness to look through the energy shock. Which of the two channels dominates in practice — a demand-suppression channel that requires an output gap to lower inflation, or an expectations-anchoring channel that can lower inflation without one — is an empirical question that the September decision, by itself, cannot answer. It can only be answered by subsequent data on output, employment and inflation compensation, a point developed further in Section VIII below.
It is also worth restating, in light of this framework, why a single month of adverse inflation data should not be treated as dispositive on its own. If August's inflation reading was driven predominantly by energy prices and by tariff pass-through — both properly understood as one-time or slow-moving shifts in the position of the short-run curve rather than as evidence of a change in its slope or in underlying trend inflation — then the appropriate Bayesian interpretation is that the level of inflation has shifted, not that the inflation process has become more persistent. The distinction matters because the two diagnoses imply different policy responses: a level shift from a supply shock is, in principle, something monetary policy can either accommodate temporarily or offset only at the cost of an output gap, whereas a genuine change in persistence would justify a sustained tightening campaign. The Committee's own reluctance to characterize its stance as restrictive, discussed in Section III, is consistent with a Committee that is treating the shock as a level shift requiring a calibrated, limited response rather than as evidence of runaway persistence requiring an aggressive campaign.
V. Testing the Credibility Framework Against the Realized Choice
The prior report's central signaling-game claim was that the credibility cost of a hold had risen materially between Jackson Hole and the September meeting, precisely because Warsh had staked out a public position emphasizing inflation persistence over employment risk. The realized decision is consistent with that claim: the Committee delivered the action its chairman's own rhetoric had implied it should deliver, and did so unanimously. This matters independent of whether the decision proves, in the fullest analytical sense developed in Section IV, to have been the economically optimal one. Credibility and optimality are different properties. A central bank can make a decision that is fully consistent with its stated reaction function and therefore credible, while that same decision later proves, on the aggregate-supply and aggregate-demand analysis above, to require a subsequent reversal. The two claims are not in tension; a credible central bank is one that acts consistently with its revealed preferences as new information arrives, not one that never has to change course.
The public reaction to the decision, captured in the live audience poll referenced during the post-meeting broadcast coverage — with a substantial majority expressing disagreement with the increase and a small minority in favor — is worth noting precisely because it illustrates the distinction. Public or market disapproval of a decision is not evidence against its credibility; it is, if anything, mild evidence that the decision imposed a real and recognized cost, which is what a demand-suppression-based disinflation strategy would be expected to do under the framework in Section IV.
VI. The Market-Expectations Story: Yields, Dissent, and the Distributional Debate
The evolution of market pricing between September 9 and September 16 is itself an important data point. The prior report's modal estimate of 55 to 60 percent probability for a hike, formed before the August CPI and PPI releases, had by the eve of the meeting hardened into a market-implied probability in the low nineties, with several surveys of professional economists showing an overwhelming majority expecting an increase. That shift over one week is the clearest available evidence that the intervening inflation data landed on the adverse side of the three scenarios this report's prior installment laid out — closer to the moderately or clearly adverse core reading than to the benign one that would have preserved the case for a hold.
Not every professional observer agreed with the outcome, and the dissenting arguments are worth engaging rather than setting aside. Moody's Analytics chief economist Mark Zandi argued publicly that a rate increase risked a serious policy mistake, on the grounds that the economy was already growing near potential and operating near full employment, and that the inflation overshoot was substantially attributable to energy prices and tariffs — supply-side pressures that, in his view, rate increases cannot directly address and that should fade on their own so long as inflation expectations remain anchored. This is, in substance, the expectations-anchoring counterargument developed in Section IV, applied as a case for inaction rather than action. A separate critique, offered by Mast Investments' chief investment officer, emphasized distributional consequences: that a hike would disproportionately burden the lower-income half of the economy that holds little in financial assets, and that the primary drivers of the inflation overshoot — tariffs, the artificial-intelligence investment boom, constrained oil supply and accumulated stock-market wealth — would be better addressed through the Federal Reserve's balance sheet than through the policy rate. Warsh's own remarks on the least-well-off in the press conference addressed this critique directly, without naming it, by arguing that price stability is itself the mechanism through which the bottom half of the income distribution ultimately benefits, since it is that group living paycheck to paycheck that is least insulated from an inflation tax.
The behavior of long-term Treasury yields over the same period reinforces the financial-conditions paradox this report's prior installment identified. The ten-year yield reached its highest intraday level since 2007 in the days before the meeting, closing near 5 percent, driven by a combination of economic strength, competition for capital from artificial-intelligence-related capital expenditure, and geopolitical risk premia tied to the energy shock — the same three factors Warsh himself cited when asked to explain the yield increase. A Committee that raises its policy rate by a quarter point against a backdrop in which long-term yields have already moved by a much larger amount is adding a comparatively modest increment of additional tightening on top of a financial-conditions adjustment that markets have already substantially delivered on their own. This is consistent with the view, discussed in Section III, that the Committee does not yet regard its own stance as restrictive.
VII. Institutional Signaling: Independence, Data Dependence, and the AI Task Force
Several elements of the press conference function less as economic argument than as institutional signaling, and are worth treating separately because they bear on the credibility question in Section V rather than on the supply-and-demand question in Section IV. Asked directly about reported presidential pressure to lower rates and about the possibility that markets would read the decision as a further test of Federal Reserve independence, Warsh declined to discuss any private conversations and characterized independence as running in both directions — implying that the Federal Reserve's deference to elected officials on trade and fiscal policy is reciprocated by deference, from those officials, to the Federal Reserve on monetary policy. A unanimous vote to raise rates against public and reported executive-branch pressure to lower them is, on its face, among the clearest available signals against the hypothesis that the September decision reflected political accommodation rather than the Committee's own reaction function.
A second institutional theme worth noting is the tension, not fully resolved in the press conference, between Warsh's continued rejection of data-point dependence and the practical reality that the August CPI and PPI releases functioned, in fact, as the decisive pivot for the September decision, exactly as this report's prior installment anticipated. Warsh's description of data dependence as a dangerous preoccupation sits somewhat uneasily alongside a decision that could not plausibly have been reached without substantial weight placed on precisely the two data releases that arrived between Jackson Hole and the meeting. The more defensible reading is that Warsh objects to public and market fixation on any single data point as a predictor of Federal Reserve behavior, rather than to the Committee's own internal use of incoming data to update its assessment of the underlying trend — a distinction between broadcasting a reaction function and being predictably steered by any one release.
Finally, the announcement of a task force on artificial intelligence, expected to report by year-end, is a forward-looking institutional development rather than an immediate policy signal, but it is directly relevant to the yield dynamics discussed in Section VI, given the role of hyperscaler capital expenditure in competing for capital and pushing up long-term yields. Warsh's explicit refusal to take a position on the substantive risks associated with frontier artificial-intelligence systems, while committing Federal Reserve resources to understanding the implications for the Committee's future policy conjuncture, is consistent with the staying-in-your-lane posture he applied throughout the press conference to questions outside the core monetary-policy mandate.
VIII. The Forward Path: The Dot Plot Versus the Supply-Curve Logic
The Summary of Economic Projections released alongside the decision points, on balance, toward further tightening rather than toward the eventual reversal implied by the aggregate-supply and aggregate-demand framework in Section IV: a majority of participants who submitted projections indicated at least one further quarter-point increase by year-end, with some favoring a larger cumulative move and only a residual few continuing to project a cut. This creates an apparent tension with the claim, developed above, that a demand-suppression-based disinflation strategy should eventually require a reversal once its output costs become visible. Two considerations help reconcile the tension rather than resolve it outright, and both point toward the same conclusion: the reversal this framework anticipates, if it occurs, lies further out than the projection horizon currently visible to the Committee.
The first consideration is that the output gap this framework implies has not yet shown up in the data the Committee is currently working from. August payroll growth of 162,000, together with upward revisions to June and July adding a combined 55,000 jobs, describes a labor market that has, if anything, firmed rather than weakened since Jackson Hole. A Committee looking at that data has little empirical basis yet for believing an output gap of the kind Section IV describes has opened; the case for further tightening in the near term is therefore not obviously inconsistent with an eventual need to reverse course once such a gap does appear. The two claims operate on different time horizons — a near-term tightening bias addressing inflation that remains unambiguously above target, and a longer-term reversal contingent on data that has not yet arrived.
The second consideration concerns the weight that should be placed on the Summary of Economic Projections itself. Warsh's own description of the median projections as belonging to his eighteen colleagues rather than to him personally, offered in response to a question about the apparent inconsistency between a decision framed as supporting a timelier return to target and a median projection pushing that same target out to 2029, is a further expression of his broader skepticism toward forward guidance as a policy instrument. A chairman who has built his public framework around minimizing the market's reliance on Federal Reserve guidance has correspondingly limited the informational content that should be attached to the Committee's own quarterly projections. This does not mean the dot plot should be ignored; it means that the near-term tightening bias it displays should be read as a conditional, data-contingent baseline rather than as a committed path, which is fully consistent with the reversal this report's supply-and-demand framework anticipates becoming visible only once subsequent data — most immediately, the October employment report and third-quarter output figures — begin to show the costs of restraint rather than only its benefits.
The single most consequential open variable, in both frameworks developed in this report, remains the Strait of Hormuz and Bab-el-Mandeb disruptions themselves. Every version of the analysis above that anticipates an eventual policy reversal depends on the short-run supply curve remaining shifted upward by an unresolved energy shock. A material de-escalation in the Gulf, restoring shipping and energy flows toward pre-conflict levels, would shift that curve back down on its own, allowing the Committee to achieve both its inflation and employment objectives simultaneously without requiring either a sustained output gap or a subsequent reversal of the September increase. The geopolitical trajectory of the conflict is accordingly not a background variable to this analysis; it is the single largest determinant of which of the scenarios developed in Section IV the economy will ultimately occupy.
IX. Conclusion: An Open Bayesian Corridor, Narrowed but Not Closed
The September 16 decision resolved the immediate question this report's prior installment posed as unsettled: whether Chairman Warsh could translate the diagnostic framework articulated at Jackson Hole into a unanimous, action-consistent decision once the intervening data arrived. It did. The Committee raised its policy rate by 25 basis points, brought a previously divided membership to a unanimous vote, and did so while explicitly declining to characterize the resulting stance as restrictive — a combination that satisfies the credibility test developed in this report's prior installment while leaving open the deeper economic question developed here for the first time.
That deeper question is whether the September increase represents progress toward resolving an inflation problem or a temporary, output-costly suppression of a problem whose underlying cause — the upward shift in the short-run supply relationship produced by the Hormuz and Bab-el-Mandeb disruptions — remains fully in place. The aggregate-supply and aggregate-demand framework developed in Section IV suggests the latter is at least as plausible as the former, and that a further reversal in the policy rate, on the order of the increase just delivered, may prove necessary once the output costs of the September decision become empirically visible, unless the energy shock itself recedes first or unless the expectations-anchoring channel discussed in Section IV proves to dominate the demand-suppression channel in practice. Neither the Committee's Summary of Economic Projections nor the September decision itself can settle which of these outcomes will occur. That determination will depend on the October employment report, third-quarter output data, and the trajectory of the conflict in the Gulf — the same three variables this report's framework has tracked since Jackson Hole, now entering a phase in which they will test not the Committee's diagnosis, but the durability of the remedy it has chosen to apply.
References
Board of Governors of the Federal Reserve System. Federal Open Market Committee statement and press conference, September 16, 2026.
Board of Governors of the Federal Reserve System. Summary of Economic Projections, September 16, 2026.
Board of Governors of the Federal Reserve System. Keynote Remarks by Chairman Kevin Warsh at the 2026 Jackson Hole Economic Policy Symposium, "In Our Time," August 28, 2026.
Board of Governors of the Federal Reserve System. Minutes of the Federal Open Market Committee, July 28–29, 2026.
U.S. Bureau of Labor Statistics. The Employment Situation — August 2026, September 4, 2026.
U.S. Bureau of Economic Analysis. Personal Income and Outlays, July 2026, August 26, 2026.
CME Group. FedWatch Tool, September 2026 readings.
Reuters. Poll of economists on the September 2026 FOMC decision, September 2026.
Reuters. Coverage of Brent crude oil prices and Strait of Hormuz and Bab-el-Mandeb shipping disruptions, September 2026.
Moody's Analytics. Commentary of Mark Zandi on the September 2026 rate decision.
Mast Investments. Commentary of Yung-Shin Kung on distributional effects of the September 2026 rate decision.
BMO Capital Markets. Commentary of Vail Hartman on Treasury market pricing ahead of the September 2026 FOMC meeting.
Macquarie. Commentary of Thierry Wizman and Gareth Berry on Federal Reserve policy ahead of the September 2026 FOMC meeting.
Goldman Sachs. Commentary of Ben Snider and colleagues on historical equity performance at the start of Federal Reserve hiking cycles.
Broadcast and wire coverage of the September 16, 2026 FOMC decision and press conference, including Yahoo Finance/Moneywise and Fox Business.
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