Tariff increases’ effects on inflation are unclear, prompting concerns from U.S. monetary policy officials about potential destabilization of inflation expectations and pricing structures. The Federal Reserve debates the risks of current tariff strategies, with differing views on their long-term impact. While some predict price rises due to cost transfers from businesses to consumers, others emphasize the economy’s adaptability. Consumer inflation expectations are rising, yet confidence in the Fed’s management of inflation remains steady amid a complex economic landscape.
The Uncertain Impact of Tariffs on Inflation
By Howard Schneider
The influence of tariff increases on inflation remains ambiguous, yet U.S. monetary policy officials are starting to express concerns about the effects of the current administration’s strategies on inflation expectations, supply chains, and pricing structures.
With the government implementing higher tariffs on Chinese goods and escalating threats towards other trading partners, officials at the Federal Reserve (Fed) argue that this approach poses a greater risk to economic stability than isolated tariff hikes. Consequently, households and businesses are faced with the challenge of adjusting to an unpredictable landscape where price increases appear imminent.
There is a significant risk that inflation expectations could become destabilized, leading to increased price volatility, according to the Fed. Meanwhile, the administration defends its tariff strategies by claiming that they will eventually help lower inflation rates.
Raphael Bostic, president of the Atlanta Fed, noted earlier this month, “Most tariff increases act as a one-off shock to the global economy, after which it tends to move forward.”
However, he cautioned that if these tariff measures, along with potential retaliatory actions, persist and influence inflation expectations, it would necessitate a monetary policy response.
In contrast, Christopher Waller, a member of the Board of Governors, expressed on Monday that he does not foresee a sustained inflation surge resulting from tariffs, emphasizing the need for central bankers to respond based on the data available to them.
He added that positioning for certain events during highly volatile periods could lead to “paralysis in monetary policy.”
Adjustments and Economic Predictions
The upcoming minutes from the last Fed meeting, scheduled for Wednesday at 19:00 GMT, may shed light on the central bank’s stance regarding these tariff issues. The Fed’s last meeting occurred shortly after Donald Trump’s inauguration, where officials were reluctant to comment on the new administration amidst rising uncertainty.
A recent analysis by the Boston Fed indicates that a 25% tariff increase on imports from Canada and Mexico, coupled with a 10% hike on Chinese imports, could contribute an additional 0.8 percentage points to U.S. inflation.
However, this analysis does not consider the myriad adjustments tariffs may incite: households might opt for alternative products or reduce consumption, businesses could absorb rising costs or transfer them to end consumers, and retaliatory measures from other nations could also play a role, alongside fluctuations in exchange rates and interest rates.
The study’s authors highlight, “The negative impact on growth could restrict the inflationary repercussions.”
During Trump’s first term, many businesses chose to absorb cost increases, yet Fed officials now observe that the private sector may be more inclined to pass these costs onto consumers, as the pandemic revealed significant pricing power.
Thomas Barkin, president of the Richmond Fed, remarked in January, “I believe companies are more likely to transfer cost increases than they were five years ago.” He warned that once this trend begins, there are valid concerns regarding the trajectory of inflation expectations, especially as consumers are still affected by the substantial price hikes experienced post-pandemic.
Andrea Raffo, research director at the Minneapolis Fed, forecasts, “Overall, prices will rise, and economic activity will decelerate.” The degree of these effects will depend on which goods are taxed and the availability of substitutes. Uncertainty will further amplify growth pressures.
A survey conducted post-Trump’s election revealed that one-third of businesses were prepared to increase their prices, with half of the respondents anticipating a price rise. Only 28% found Trump’s assertion that foreign companies would absorb tariff increases plausible.
Currently, Fed officials report that market and consumer confidence in the central bank’s ability to manage inflation remains intact. The central bank’s rates continue to be viewed as restrictive, aiding in the reduction of inflation.
Nevertheless, early warning signs are beginning to surface.
The University of Michigan’s survey indicated a notable rise in consumer inflation expectations, although a separate sentiment survey by the New York Fed did not reflect a similar increase. Market inflation expectations have also risen, but Fed Chairman Jerome Powell and other officials maintain that these levels remain aligned with the goal of achieving the inflation target.
The unique state of the U.S. economy, characterized by low unemployment, growth surpassing historical trends, strong consumer spending, and businesses poised to raise prices, complicates reliance on experiences from Trump’s first term when growth lagged behind potential and inflation stayed below 2%.
Austan Goolsbee, president of the Chicago Fed, noted that the economy initially adapted quickly to the initial shocks from tariffs in 2018. “Businesses likely moved everything that could be easily relocated out of China, leaving only the least substitutable goods,” he explained. In such cases, the inflation shock could be more pronounced, and the effects on intricate supply chains should not be underestimated.
The pandemic highlighted how disruptions and the restructuring of logistical networks could create lasting price pressures.
“The entire supply side of the economy cannot be neglected,” Goolsbee concluded.