Tariffs make two challenges for the Fed. Uncertainty about policy may slow capital spending, pointing to lower interest rates. But tariffs will cause higher prices.
Two months into the second Trump administration the Federal Reserve decided to keep their policy interest rate unchanged. That stance will likely continue, though most Fed policymakers expect otherwise.
Tariffs present two different challenges that may point the Fed in different directions. Uncertainty about where we will end up with trade policy may slow business capital spending and hiring, which could lead the Fed to ease interest rates. But tariffs will also cause higher prices, which will feel to consumers like inflation. How will the Fed react to that?
Federal Reserve policymakers will try to fulfill their mandate to keep prices low with maximum employment. Policymakers are human and have opinions about the president, but they will most likely put their political preferences aside as much as they can. Even where I disagree with their policies, I believe that they have high integrity to do what they are charged to do.
Economists have attempted to measure uncertainty, most notably the Economic Policy Uncertainty index. But quantifying the size of policy uncertainty’s effects is extremely difficult. When policy uncertainty is high, other factors also are affecting the economy negatively, so it’s not at all clear the magnitude of uncertainty’s own effect. That said, the logic of an impact is solid, even if quantification is soft.
Policy uncertainty that slows business capital spending and hiring should be countered by stimulative demand management policies.
