– Tariffs May Boost Both Inflation, Unemployment; Give Fed ‘Difficult’ Choices
– FOMC May Have to Make ‘Difficult Judgment’ in Balancing Inflation, Job Goals
– Fed Chief Refrains from Saying FOMC Is In ‘No Hurry’
By Steven K. Beckner
(MaceNews) – Federal Reserve Chair Jerome Powell said Wednesday the economy and labor market remain “solid” for now, but warned that heightened economic risks from the Trump administration’s trade policies could begin to put monetary policy in a “difficult” position.
Powell, speaking after a stormy period in financial markets caused by President Trump’s campaign of reciprocal tariffs and combative trade stance toward China, said the tariffs could cause both “higher inflation and slower growth.”
In such a “challenging scenario,’” the Fed would have to make “a likely difficult judgment” after considering how far the economy is from its “maximum employment” mandate and its 2% inflation target and how long it will take to reach those respective goals, he told the Economic Club of Chicago.
Conspicuously absent from Powell’s remarks was any repetition of his previous statements that the Fed needs to be in “no hurry” to adjust interest rates, as he discussed monetary policy dilemmas three weeks ahead of the next meeting of the Fed’s policymaking Federal Open Market Committee.
At its March 19 meeting, the FOMC voted to leave the federal funds rate unchanged in a target range of 4.25% to 4.5%., while tilting toward further rate cuts. The 19 FOMC participants projected the policy rate will end 2025 at 3.9% (a range of 3.75% to 4.00%) in the quarterly Summary of Economic Projections – the same as in the December SEP.
At the same time, the FOMC voted to slow the pace of shrinkage in its portfolio of Treasury securities or “quantitative tightening.” The FOMC will meet again May 6-7 but will not publish new funds rate projections until June.
In his most recent speech on April 4, Powell reiterated what he had said since the beginning of the year – that the Fed’s “moderately restrictive” monetary policy is “well-positioned” to respond to economic developments and that the FOMC need be “in no hurry” to adjust interest rates.
Wednesday, Powell refrained from reiterating that cautious, patient approach, either in prepared remarks or in answer to questions. although neither did he indicate that the FOMC is getting close to making a policy change.
Beginning on an upbeat note, the Fed chief said that “despite heightened uncertainty and downside risks, the U.S. economy is still in a solid position. The labor market is at or near maximum employment. Inflation has come down a great deal but is running a bit above our 2% objective.”
Powell said the unemployment rate is in “a low and stable range,” and he added, “Overall, the labor market appears to be in solid condition ….”
Meanwhile, “inflation has significantly eased” and “progress on inflation continues at a gradual pace,” he said, estimating that core PCE prices rose 2.6% in March.
But shifting to the outlook, Powell sounded much less optimistic as he spoke of the “highly uncertain” impact of tariffs and other administration policies.
“The level of the tariff increases announced so far is significantly larger than anticipated,” he said. “The same is likely to be true of the economic effects, which will include higher inflation and slower growth.”
Powell said the Fed is still trying to understand the potential impact of tariffs, but said they are “highly likely to generate at least a temporary rise in inflation.” And he warned “the inflationary effects could also be more persistent.”
Although he noted that near-term inflation expectations have risen, Powell said longer term inflation expectations have remained “well anchored,” and he said the Fed’s obligation is “to make certain that a one-time increase in the price level does not become an ongoing inflation problem.”
As he and his fellow policymakers pursue that mission, Powell said, “we will balance our maximum-employment and price-stability mandates ….,” but he warned, “We may find ourselves in the challenging scenario in which our dual-mandate goals are in tension.”
“If that were to occur, we would consider how far the economy is from each goal, and the potentially different time horizons over which those respective gaps would be anticipated to close,” he added.
In response to a question about how the FOMC will conduct monetary policy if both inflation and unemployment go up, Powell elaborated on its self-prescribed “balanced approach.”
“Most of the time when the economy is weak, inflation is low and unemployment is high, and … both call for lower interest rates to support activity,” he observed. “Most of the time our goals are not in tension .…”
“But the shock we’re feeling (portends) higher unemployment and higher inflation, and our tool (the funds rate) only does one of those two things at the same time,” he continued.
“That‘s a difficult situation to be in …,” he went on. In that case, “we will look at how far the economy is from each of those two goals … ask might there be different paces at which we approach those two goals … and make a likely difficult judgment.”
In recent weeks, other Fed officials have also said the FOMC would take “a balanced approach” if unemployment rises while inflation remains above the Fed’s 2% target.
As enunciated in the Fed’s Statement on Longer-Run Goals and Monetary Policy Strategy, if the FOMC determines that its maximum employment and price stability objectives are “not complementary, it takes into account the employment shortfalls and inflation deviations and the potentially different time horizons over which employment and inflation are projected to return to levels judged consistent with its mandate.”
In other words, if the FOMC decides inflation is closer to target than unemployment it would use monetary policy to respond first to unemployment. Although the FOMC does not have a formal unemployment target, it does estimate the “longer run” rate of full employment – sometimes called the “non-accelerating inflation rate of unemployment” (NAIRU) – at 4.2%.
Asked about financial market volatility, Powell responded that “the markets are struggling with a lot of uncertainty,” but he emphasized that “markets are functioning (and) they’re orderly.’
Powell did not downplay the costs of uncertainty, however, warning it could cause both households and businesses to refrain from making spending and investment decisions and make the United States a “less attractive” place to put money.
Other Fed officials have also been trying to come to terms with constantly changing tariff picture. The general consensus, echoing Powell, is that the outlook is fraught with more than the usual amount of uncertainty.
Earlier Wednesday, Cleveland Federal Reserve Bank President Beth Hammack called recent economic data “encouraging,” but said “heightened uncertainty surrounding government policies is clouding the outlook.”
She said, “it will take some time” for the economic effects of tariff and other government policy changes “to become clearer,” but cited “risks around both legs of our dual mandate that could lead to higher inflation outcomes and to lower growth and employment outcomes.” And she said these risks will be “difficult … for monetary policy to navigate.”
Hammack, who dissented against the FOMC’s third rate cut in December, advised holding policy steady for the time being. “Given the economy’s starting point, and with both sides of our mandate expected to be under pressure, there is a strong case to hold monetary policy steady in order to balance the risks coming from further elevated inflation and a slowing labor market. When clarity is hard to come by, waiting for additional data will help inform the path ahead.”
“With inflation elevated, the current modestly restrictive stance for monetary policy is appropriate to continue the downward pressure on inflation so that it returns to our goal in a timely fashion,” she continued. “If the economy should falter and inflation decline, then it may be appropriate to ease policy by lowering the federal funds rate from its current level of 4-1/4 to 4-1/2 percent, perhaps even quickly.”
On the other hand, “if the labor market remains healthy and inflation moves up persistently, then monetary policy may need to follow a more restrictive trajectory,” Hammack said.
“But if elevated inflation is paired with a slowing labor market, then monetary policy will face some challenging trade-offs,” she added. “In that case, it will be important to ensure inflation expectations remain well anchored while assessing the likely magnitude and persistence of the misses to each side of our dual mandate goals.”
For now, though, “we will simply have to see how events unfold,” she said, “I would rather be slow and move in the right direction than move quickly in the wrong direction.”
On Monday, Gov. Christopher Waller opined that “tariffs this large and broadly applied could significantly affect the economy and the Federal Open Market Committee’s pursuit of our economic objectives.” But he said the exact impact will depend on the ultimate size and extent of tariffs after trade negotiations have concluded. He presented two scenarios – one in which “large tariffs” prevail, another in which tariffs prove to be smaller.
In the first scenario, Waller said inflationary effects would likely be “temporary,” but “their effects on output and employment could be longer-lasting and an important factor in determining the appropriate stance of monetary policy.”
“If the slowdown is significant and even threatens a recession, then I would expect to favor cutting the FOMC’s policy rate sooner, and to a greater extent than I had previously thought …,” he elaborated. “With a rapidly slowing economy, even if inflation is running well above 2%, I expect the risk of recession would outweigh the risk of escalating inflation, especially if the effects of tariffs in raising inflation are expected to be short lived.”
In the lower tariff scenario, Waller said “the effect on inflation would be significantly smaller than if larger tariffs remained,” while the negative effect on output and employment would likewise be “smaller than the larger tariff scenario….” In that event, he “would support a limited monetary policy response …. With the threat of a sharp slowdown or recession diminished, pressure to reduce rates based on falling demand would diminish also.”
“That is, the policy response in this scenario could allow for more patience,” he added.