Key Takeaways
- Federal Reserve officials said this week that they are wary of tariffs’ effect on the economy and are waiting to see how they turn out before adjusting monetary policy.
- Tariffs could push up prices, stoking inflation, but also could drag down the economy, hurting the job market.
- Both risks would call for opposite responses from the Fed, which can boost the economy or throw sand in its gears by adjusting the fed funds rate, which affects borrowing costs.
The economy’s trajectory largely depends on how President Donald Trump’s tariff-raising spree turns out, according to Federal Reserve officials who made public remarks this week.
In various public appearances, a half-dozen Federal Reserve policymakers said they were keeping a close eye on Trump’s trade policies. Several predicted the president’s tariffs would stoke inflation, slow down the economy, or both. That would complicate the Fed’s job, a dual mandate to keep both of those forces at bay using monetary policy.
Fed officials have joined many other economists in predicting that Trump’s tariffs, intended to protect American businesses from foreign competition, would push up the cost of living and hammer household budgets. Trump announced a 25% tariff on imported cars this week and is planning another round of tariffs against numerous foreign countries on April 2.
“It looks inevitable that tariffs are going to increase inflation in the near term,” Susan Collins, president of the Federal Reserve Bank of Boston, said Thursday at a fireside chat. “My kind of modal outlook would be that that could be short-lived with a continuation of some disinflation, but further in the future than I might have expected before. But there are risks around that, and depending on how things unfold, it may be more persistent and a larger increase.”
What Will the Fed Do With the Uncertainty?
The Fed typically has one major way to combat inflation: keeping its benchmark interest rate, the federal funds rate, high in order to push up rates on all kinds of loans and slow down economic activity.
Yet, financial markets are projecting the Fed will cut its benchmark interest rate three times this year to combat the lingering remnants of the post-pandemic surge of inflation. That’s according to the CME Group’s FedWatch Tool, which forecasts rate movements based on fed funds futures trading data.
Forecasters are betting the Fed will be forced to cut rates later this year because of its other major mandate, which is to prevent a severe rise in unemployment. A slowdown in consumer spending could hurt the job market, a risk that Minneapolis Fed President Neel Kashkari alluded to when speaking at an event in Detroit Wednesday. He commented on the plummeting levels of consumer confidence shown by recent surveys.
“It’s conceivable that the hit to confidence could be a bigger effect than the tariffs themselves,” he said.
Raphael Bostic, president of the Atlanta Fed, said he was keeping an eye on both risks in an interview on Bloomberg TV Monday. He said he expects inflation to remain stubborn this year and forecasts the Fed would only cut interest rates once. More tariffs from Trump could push him toward delaying rate cuts more, while a decline in consumer confidence or a rise in unemployment could bring about rate cuts sooner, he said.
Fed Governor Adriana Kugler, speaking to the Hispanic Chamber of Commerce in Washington on Tuesday, noted that Trump’s trade policies were raising consumers’ inflation expectations.
“I am paying close attention to the acceleration of price increases and higher inflation expectations, especially given the recent bout of inflation in the past few years,” she said in prepared remarks.
Will Tariff-Related Inflation Be Temporary?
In theory, a tariff could be a one-time increase in prices and not necessarily increase inflation, which is, by definition, sustained price increases over time. In that case, the Fed could be safe ignoring it.
However, a jump in prices could affect individuals and businesses psychologically, and lead them to make decisions that push up inflation in the long term. Alberto Musalem, president of the St. Louis Fed, said he was concerned about that, speaking at a monetary policy event in Kentucky.
“I would be wary of assuming that the impact of tariff increases on inflation will be entirely temporary or that a full ‘look-through’ strategy will necessarily be appropriate,” he said, according to prepared remarks.
The multitude of uncertainties and risks makes predicting what the economy will do nearly impossible, Tom Barkin, president of the Federal Reserve Bank of Richmond, said in a speech Thursday at Washington and Lee University. He compared the task of setting monetary policy under the current conditions to driving a car through the fog.
“With all this change, a dense fog has fallen,” he said, according to prepared remarks. “It’s not an everyday, ‘forecasting is hard’ type of fog. It’s a ‘zero visibility, pull over and turn on your hazards’ type of fog.”
Barkin said the Fed was unlikely to change interest rates until the fog began to lift.