The Federal Reserve is about to face a multidimensional challenge it hasn’t faced in decades. Deeply concerning are the impacts that the tariff increases being introduced by President Trump’s administration will have, potentially steering the U.S. economy towards stagflation. All-time high unemployment combined with double digit inflation spells economic disaster. This threatens the Fed’s dual mandate to support maximum employment and stabilize prices. Federal Reserve Chair Jerome Powell has made it clear that if stagflation does come to pass, the central bank will have to rethink its priorities.
Specific temporary exemptions for some electronic merchandise were just announced by the administration. As far back as May, Trump has been telegraphing that the next round of tariffs would be aimed at semiconductors, pharmaceuticals, copper and timber. The scale of these tariff increases is considerably larger than analysts had previously anticipated, raising alarm among economists and policymakers.
Economic Implications of Tariffs
Unfortunately, the specter of stagflation hangs over these rosy predictions as too many projections indicate that the U.S. economy appears to be headed in that direction. During the 1970s and early 1980s, the nation grappled with similar economic challenges, experiencing both high unemployment and escalating inflation. Powell stressed the need for rigorous analysis of the impact these tariffs will have on overall economic conditions.
“We understand that elevated levels of unemployment or inflation can be damaging and painful for communities, families, and businesses,” – Jerome Powell
From that perspective, it doesn’t matter whether the Fed has previously put a strong emphasis on fighting inflation, even if it causes short-term pain. This misguided strategy was first famously put into practice under former Fed Chair Paul Volcker. Powell’s current stance reflects a cautious approach: the Fed will remain patient until clearer data emerges regarding the economy’s response to these tariffs.
Beth Hammack, Goldman’s chief economist, reflected on their discussions and where things stand. “All of these,” she cautioned, “are a tricky combination of risk for monetary policy to juggle.” Reinhart noted that next month’s data will be especially important in figuring out what’s next for the Fed.
Monitoring Inflation and Employment
Core inflation is still slightly above the Fed’s 2% target. This makes it less politically attractive to cut interest rates in the immediate term. The latest economic data indicates that while challenges exist, the overall condition of the U.S. economy remains relatively stable for now. Powell reiterated the need to keep a close eye on what consumers are saying about prices. According to the University of Michigan’s consumer sentiment survey, those perceptions have been getting worse.
Regular Monetary Policy
Bee Austan Goolsbee observed during his time on the White House Council of Economic Advisors that tariffs accomplish the goal of a “negative supply shock.” He continued, “A tariff is basically a bad supply shock. This is a bad stagflationary shock. It simultaneously exacerbates one side of the Fed’s dual mandate while making the other side even harder. He further remarked on the unique difficulties posed by this situation: “Prices are going up while jobs are being lost and growth is coming down, and there is not a generic playbook for how the central bank should respond to a stagflationary shock.”
The Fed’s Strategic Response
Given these hurdles, Powell gave a clear picture of the Fed’s plan from here on out. As he put it, “First, we will determine how far the economy is from each goal. We’ll take into account the varying time horizons in which we expect these gaps to close.” This has the dual benefit of acknowledging a more nuanced approach to policy—that the Fed will need to tailor its response as new economic signals continue to develop.
The ability of tariffs to affect inflation and employment in opposing directions poses serious questions for the pursuit of the central bank’s dual mandate. If only the administration were consistently deploying tariffs this way. This latest move increases the scrutiny on the Fed to manage its dual mandate particularly well.
