(Bloomberg) -- Federal Reserve Bank of Philadelphia President Anna Paulson said she will keep an open mind about the path for interest rates, focusing on the trends of underlying inflation.
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"I see two plausible scenarios for how current policy is affecting inflation, and the incoming evidence will clarify which path we're on and what adjustments, if any, may be needed," Paulson wrote in an essay Tuesday. "I am keeping an open mind about where policy goes from here."
In the first scenario, further evidence of improving inflation data and stable expectations for future prices should indicate that interest rates are "mildly restrictive" and help bring inflation back to the Fed's 2% goal "in an acceptable time frame," she said.
However, the fact that underlying inflation has "edged down modestly" over the last year could also point that rates are "not restrictive enough," Paulson said.
"If instead underlying inflation remains stubbornly elevated, the passage of time without progress would itself signal that more restrictive policy is needed," said the Philadelphia chief, who votes on monetary policy this year.
Fed officials kept interest rates unchanged for the fifth straight time last week. Still, three other policymakers dissented in favor of a quarter-point hike, arguing a modest tightening of monetary policy would reduce risks of more aggressive hikes later.
Recent economic data continues to give Fed officials some relief. The central bank's preferred measure of inflation, the personal consumption expenditures price index, fell 0.1% in June, with gauges excluding food and energy rising less than expected. Inflation-adjusted consumer spending climbed 0.4%, matching the strongest pace since July of last year.
"The recent improvement in some inflation data is welcome. It is a step in the right direction, but it is only one step," Paulson said on Tuesday. Underlying inflation, she estimates, runs somewhere between 2.4% and 2.8%.
"Underlying inflation has been elevated for a long time, and it is what I am most focused on as I evaluate our progress toward the 2 percent target," she added.
The Philadelphia chief said the labor market appears stable. She also noted the conflict in the Middle East has caused uncertainty and pushed inflation up, while the buildout around artificial intelligence infrastructure has created price pressures in some areas while also driving growth.