The Federal Reserve has chosen to prop up a flailing economy and labor market over price stability.

The 2018 Tax Cut and Jobs Act and President Biden’s infrastructure, industrial and social welfares policies boosted federal deficits from 2.9% of GDP in 2016 to 6.6% last year.

Those powered 2.5% annual GDP growth from 2017 to 2024.

The Big Beautiful Bill juices federal deficits a bit more than $300 billion a year, but President Trump’s tariffs will generate a similar amount of new revenue.

Absent additional fiscal stimulus, economic forecasters in January expected growth to slow to 2.0% this year but with the supply chain disruptions imposed by Trump’s tariffs, they have lowered their expectations.

We haven’t seen the full impact of tariffs on prices, but headline and core inflation remain closer to 3% than the Fed’s 2% target.

Many businesses haven’t pushed through all their increased tariff costs. With those in flux, businesses are uncertain about the prices they can charge and what they will ultimately be paying for materials, components and goods for resale.

Price restraint can’t last.

In a slowing economy, shareholder pressure forces business to increase profits by not filling vacant positions, trimming other expenses and boosting productivity.

Those strategies have limits, and the University of Michigan and Conference Board surveys of consumer expectations peg one-year inflation at 4.8% and 6.2%.

Unemployment remains low, but job listings, resignations and layoffs are below pre-and post-COVID shutdown levels and net hiring is near zero.

For workers with jobs, inflation-adjusted incomes are rising. Those without jobs and new graduates face hard times finding work.

Businesses are using Artificial Intelligence to reduce headcount, and a stagnant labor market is creating fear among the middle-class.

It’s no surprise that Trump pressured the Fed to lower interest rates and is contemplating declaring a national housing emergency to ease building codes and lower tariffs on construction material.

But construction activity is limited by the availability of buildable land close to large employment centers, and Trump’s deportation and strict immigration policies limit labor supplies in the construction sector.

Home buyers may use lower mortgage rates to simply bid up prices.

Housing is 35% of the Consumer Price Index and lower interest rates could ultimately become rocket fuel for inflation.

All that put Fed between a rock and a hard place.

If it charts a cautious path on inflation, it lets a tough jobs market fester but if it follows through with a rate cutting cycle, it risks making 3% inflation the new normal.

Moreover, the Fed can set the federal funds rate—the overnight rate the banks charge each other for funds. But consumer and business loans often benchmark off the 10-year Treasury rate, which doesn’t always move with the federal funds rate.

From September to December 2024, the Fed lowered the short-term target rate by a percentage point, but increased federal borrowing pushed up the 10-year Treasury and mortgage rates.

Many forces could again push that bellwether rate up.

AI spending is creating huge demands for new capital. Should President Trump’s tariffs boost manufacturing, expanding factories will be capital intensive too.

NATO allies in Europe are increasing defense spending. Their coalition governments can’t easily cut social programs and taxes on the continent are already burdensome.

Hence, European governments will be borrowing more and competing with the U.S. Treasury for international investors’ funds.

The baby boom generation will be drawing down savings during their retirement years but the smaller cohort who follow in their wake are not saving as much for their golden years.

On net, that spells a drain on savings available to finance business investment and government debt.

Trump’s attacks on Federal Reserve independence undermine confidence in U.S. government bonds as a durable store of value and push up interest rates.

Reforms following the Global Financial Crisis discourage banks from making markets in government and corporate debt.

Often, large banks provided a cushion in times of distress—buying bonds during selloffs—to ease losses for big clients for other services, because banks were confident bond prices would eventually rebound offering them a profit.

That cushion is now reduced, making even federal debt and top-rated corporate bonds potentially more volatile. And investors should want higher interest rates to compensate.

Consequently, even as the Fed lowers short-term rates, a 10-year Treasury rate that is the sum of long-term expected inflation and economic growth—or 4.5% to 5%—is more likely.

Moreover, the Fed can’t fix the disruptions AI imposes on labor markets—many managerial and professional roles are being displaced by decision-making software called agents.

Lowering the federal funds rate, may take the heat off the Fed from the White House but historians may well blame Chairman Powell for locking in 3% inflation.

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Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.