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Takeaways
- Federal Reserve officials are bracing for President Donald Trump's tariffs to impede both of the central bank's goals of keeping inflation in check and employment high.
- Fed officials said that tariffs may increase consumer prices and cause inflation, slow down the economy, or cost jobs.
- A combination of rising inflation and unemployment could force the Fed into a difficult decision between saving the economy and fighting inflation. Its monetary strategy can only help with one of the problems at a single time, and may even make the other problem worse.
Federal Reserve officials said this week that the U.S. economy will see higher inflation and slower growth due to President Donald Trump’s trade war.
Central bankers are waiting, just like other experts, to see how trade wars will unfold. Several Fed officials have said that they expect consumer prices will rise and economic growth will slow, which will worsen the outlook for both sides in the Fed’s dual mandate to keep inflation low while employment is high.
Susan Collins, the president of Federal Reserve Bank of Boston (FRB Boston), spoke to Yahoo! Finance Friday. She said that she expects an inflation rate of “well above 3%” in this year. It would be a disappointment, since the Fed’s goal was to achieve a 2% inflation rate measured by Personal Consumption expenditures. Core PCE increased by 2.8% in February.
Collins told the Financial Times in a separate conversation that the central banks “would be absolutely prepared” to stabilize the financial markets, if they became disorderly. Stocks have soared and bond prices plummeted in recent weeks in response to Trump’s steep tariffs. He then announced on Wednesday that most of the tariffs would be suspended for 90-days.
Alberto Musalem was the president of St. Louis Fed, stated that the central banks monetary policy could be used to “lean” against tariff-driven increases in prices. Musalem was speaking at a bankers’ convention in Arkansas last Friday when he said that he disagreed with the “textbook view” that the Fed ignores tariff-driven price hikes because, in principle, they are one-time events.
Musalem acknowledged that high inflation and a slowing economy would place the Fed in a “challenging position”.
The Federal Reserve’s primary tool to combat inflation and keep the labour market afloat, is changing the federal fund rate. This rate influences the borrowing costs for all types of loans. The Fed could lower the rate in order to stimulate the economy by providing easy money and preventing unemployment. It can also raise the rate in order to reduce inflation and borrowing by allowing supply to rebalance.
But it cannot do both simultaneously. The Fed has maintained its rate at a high level in recent months in order to suppress the last embers from the post-pandemic surge inflation. Although it has decreased significantly since 2022, the rate is still higher than the Fed’s annual target of 2%.
Austan Goolsbee of the Chicago Fed said that the tariffs would likely cause both inflation and economic stagnation simultaneously, a condition known as “stagflation.”
Goolsbee, a member of the Economic Club of New York, said that prices are rising while jobs are lost and growth is decreasing. “There is no generic playbook on how the central banks should respond to a shock of stagflation.”
Jeff Schmid, President of the Federal Reserve Bank of Kansas City said that if forced to choose between maintaining the labor market and keeping prices in check, he would prioritise fighting inflation.
Schmid told business leaders in Kansas City that there was a growing likelihood that the Fed may have to balance inflation concerns against growth and job concerns when setting policy. “When considering this balance, I will keep my eyes firmly focused on the inflation outlook.”
