President Donald Trump has radically altered U.S. foreign and trade policies and challenged judicial supremacy but so far, has tolerated Federal Reserve independence on monetary policy.
He’s lobbied for lower interest rates to cushion the negative macroeconomic effects of his tariffs but if Chairman Jerome Powell ignores him, he can’t likely fire him.
Trump’s Inflation Nation
Running for reelection, Trump promised to cut taxes and regulations and impose tariffs. But Wall Street and business leaders wrongly assumed tax and regulatory relief would come quickly and tariffs only after efforts to negotiate better terms of trade with Europe, China and others.
No one seriously considered a wholesale assault on global supply chains with big tariffs on key suppliers like Canada and Vietnam.
Instead, tariffs are coming quickly, deregulation is a slower process and tax cuts depend on Congress and won’t likely arrive much before 2026.
The Fed is challenged to pull down core inflation. The Consumer Price Index less food and energy rose 2.8% in March, because of persistent price and cost pressures in the services sector.
Even with suspending many of the largest reciprocal tariffs, the average duty on imports is up about 20 percentage points since Inauguration Day. That will reverse recent progress on goods inflation.
Those won’t be one-off effects as Treasury Secretary Scott Bessent argues. Rather, those will become imbedded in workers’ wage demands.
Trump’s tax cuts generally aren’t targeted to boost investment and productivity.
Exemptions for tips and social security benefits will distort labor markets.
The 2017 Jobs Tax Cut and Jobs Act, lowered the corporate rate at 21%, made U.S. business taxes more than competitive with other major economies—slashing to 15% won’t do much more good.
By boosting the federal deficit to well above 7% of GDP, those will compound the inflationary effects of the tariffs and could hoist inflation close to 4%.
Just getting below 3% again will likely require the Fed to push up interest rates just as the economy is slowed by tariffs and faces a greater than even chance of a recession.
Abandoning the 2% Target
Appeasing Trump would require the Fed to implicitly abandon its 2% target, and pressure is mounting for that.
All along, Powell has pursued a soft-landing—inflation near target but without enduring a recession. 2.8% isn’t that!
At Congressional hearings, Senator John Kennedy (R.,-LA) said Powell should take credit for accomplishing a soft landing—that would imply just below 3% is the new target.
Before COVID, inflation averaged 1.5% for more than a decade, the Fed faced pressure from progressive economists to adopt a higher target. Lately more moderate commentators have joined that chorus.
Bloomberg columnist John Authers has suggested the current pace of inflation is “ now within the 3% upper range of the Federal Reserve’s target.” That’s curious, because the Fed hasn’t expressed its target in terms of a range.
Respected economist, financial columnist and President of Queens College, Cambridge Mohamed A. El-Erian has suggested that structural conditions have sufficiently changed since the pre-COVID period to justify a higher target. He notes that 2% was a somewhat arbitrary choice without sufficient analytical underpinnings.
Sticking to the Target
The Fed is charged with accomplishing both price stability and maximum employment, and we should look to Alan Greenspan’s definition of the former: “Price stability is that state in which expected changes in the general price level do not effectively alter business or household decisions.” Otherwise, consumers would constantly try to accelerate purchases of big items like appliances and cars, and inflation would be inclined to continuously accelerate.
At 2.8% and Trump implementing much higher tariffs, consumers are expecting much higher inflation. In April, the University of Michigan survey recorded a one-year expectation of 6.7%.
A Reckoning for the Fed
The Fed will have to choose.
The economy was already bound to slow even before Mr. Trump threatened tariffs and if he continues with the tariffs he’s implemented, we’ll likely see economic growth in the range of 1% or less while inflation accelerates.
Even at 1% growth, unemployment would rise and the white-collar problem—middle managers and administrative workers facing shrinking opportunities owing to Artificial Intelligence—will worsen.
If the Fed chooses to reflate the economy, inflation could easily rise above 4% and be inclined to accelerate from there.
If the Fed enables Trump’s reckless macroeconomic and tariff policies and fails to put the skids on reaccelerating inflation, we could lose grasp of price stability for a decade or more.
A repeat of the 1970s, when the Fed alternated between hitting the gas and tapping the brakes gradually took inflation to double digits, stagflation becomes a significant risk.
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Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.