Fed faces thorny decisions as it weighs when to lower interest rates amid Trump's tariffs
Paul Davidson, USA TODAY
6 min read
Federal Reserve Chair Jerome Powell was expected to be grilled by U.S. lawmakers Tuesday about when the central bank will resume its interest rate cutting campaign after pausing last month amid elevated inflation and turmoil surrounding President Donald Trump’s economic policies.
He may not have many answers.
Trump’s tariffs and immigration crackdown, among other policies, have generated unusual uncertainty about the course of inflation and the economy, leaving the Fed decidedly in wait-and-see mode.
“We’re only just beginning to see – actually, are not really beginning to see much, and I think we need to – we need to let those policies be articulated before we can even begin to make a plausible assessment of what their implications for the economy will be,” Powell said at a news conference in late January after the Fed held its key rate steady.
Powell was set to testify before the Senate banking committee at 10 a.m. ET.
Chicago Federal Reserve Bank President Austan Goolsbee speaks at the Council on Foreign Relations in New York.
Austan Goolsbee, president of the Federal Reserve Bank of Chicago, didn’t provide much more clarity on what the Fed will do but did offer some insight on how it could grapple with the often-conflicting crosscurrents of Trump’s economic plan.
“Yes, there have been proposals on tariffs, but there also have been proposals on deregulation, and there have been proposals on cutting corporate taxes and there have been a bunch of things − which, what matters? What’s all of that combined going to do to employment or prices?” Goolsbee, a voting member of the Fed’s rate-setting committee this year, told USA TODAY. “And that’s what we need to think through.”
What causes interest rates to increase or decrease?
The central bank raises rates or keeps them higher for longer to cool the economy and curtail inflation. It lowers rates to stimulate a softening economy and job market or bring rates loser to normal as inflation subsides.
Fed officials have forecast two rate cuts this year, but some economists think the Fed will have to stay on hold.
Goolsbee is broadly considered one of the Fed’s more dovish members, meaning all things equal, he may be more likely reduce rates sooner to bolster a teetering economy and less likely to raise them quickly if inflation is picking up.
As long as inflation continues to drift down to the Fed’s 2% goal and the labor market doesn’t heat up so much that it threatens to push up prices, Goolsbee said, “I think rates will go down a fair amount more in coming months.”
And despite an unemployment rate that dipped to an eight-month low of 4% last month, job growth has been volatile after hurricanes and labor strikes but has averaged under 200,000 the past four months, Goolsbee noted.
“This is not what an overheating economy looks like to me,” he said.
Fed Governor Christopher Waller, considered more hawkish and more apt to keep rates high to fight inflation, said he’s not worried about tariffs because they represent a “one-time” increase in prices. In other words, annual inflation should return the following year to where it was.
Also, the Fed’s rates are aimed at reducing inflation by cooling consumer demand for products and services. Waller's view is consistent with the idea that keeping rates high may not be relevant in this case because it’s tariffs that are raising prices, not consumer spending, Goolsbee said.
Goolsbee, though, isn’t so sure. What if higher prices from tariffs, he suggested, lead workers to demand bigger raises, which in turn feed into still-higher prices? And what if tariffs increase the inflation expectations of consumers and business, prompting further increases in wages and prices?
“You don’t want a wage-price spiral,” Goolsbee said.
He said he’ll also be closely watching consumers’ long-run inflation expectations. “I do think that’s very important” whether the world believes “whatever gyrations you’re seeing on inflation are going to last or not going to last.”
Another conundrum: What if inflation rises at the same time tariffs are in effect and the job market is strong? What’s causing prices to rise – tariffs or the hot job market?
“We’re going to be in an uncomfortable position if that starts to happen,” Goolsbee said.
Goolsbee said he likes to talk to the Fed’s contacts in various industries to distill myriad forces and connect the dots between cause and effect.
That, he said, is “the only way you can truly disentangle … what part is coming from interruptions versus what part is coming from overheating.”
Noting he recently spoke to auto industry players, he said parts suppliers hit with tariffs likely would would try to persuade automakers to pay them higher prices "but they might refuse. So they might get stuck eating it."
"You've got to kind of come to a judgement about that before you know how fast (price increases) would filter through" to consumers, he said.
Goolsbee also said Fed officials shouldn’t wait until tariffs actually push up prices before factoring them into their interest decisions.
“I do not believe we should be purely backward-looking,” he said. “We have to think about the outlook.”
How much did the Fed cut its key rate?
From September through December, the Fed cut its key interest rate by a percentage point to a range of 4.25% to 4.5% after a pandemic-induced inflation spike eased substantially. But since fall, the Fed’s preferred inflation measure has been stuck at just under 3% − down from a peak of 5.6% in 2022 but above its 2% goal.
Inflation is likely to resume its descent the first half of the year before Trump’s trade and immigration plans partly reignite consumer price increases by the second half, Barclays says.
Trump placed a 10% tariff on imports from China last week and delayed a 25% levy on shipments from Canada and Mexico for 30 days while the countries try to comply with the president’s demand to halt or slow fentanyl crossings into the U.S.
Trump also has begun deporting what could be millions of immigrants without permanent legal status and said he’ll sock all steel and aluminum imports with a 25% tariff to spur manufacturers to move production of those materials to the U.S.
What is a tariff in simple terms?
Tariffs are taxes on goods shipments paid by importers such as U.S. retailers and manufacturers, and most are likely to be passed to consumers through higher prices, according to Moody’s Analytics. Deportations, meanwhile, are likely to constrict the labor supply, especially in industries such as construction, agriculture and restaurants, driving up wages and prices, Oxford Economics says.
At the same time, tariffs and deportations are expected to dampen the economy by giving consumers less purchasing power and erasing the spending of foreign-born residents ousted from the country, the research firms have said.
Further muddying the picture: Trump’s plans to loosen regulations on businesses while cutting taxes are expected to juice both the economy and inflation.
Is the Fed rate going to increase or decrease?
And what if tariffs and deportations are lifting inflation at the same time they’re hampering the economy? Does the Fed raise rates, keep them steady or lower them?
“You kind of can’t answer that unless it actually happens,” Goolsbee said. “The Fed’s job is to stabilize prices and maximize employment both. If those two goals end up in conflict in the short run, it would depend on the context how we should react.”
