"I would be wary of assuming that the impact of tariff increases on inflation will be entirely temporary," Musalem said during a speech in Kentucky.
"The direct price-level effects [of tariffs] are expected to have only a brief and limited impact on inflation, but the indirect effects could have a more persistent impact on inflation," he added.
Powell raised eyebrows when he told reporters his "base case" was that any higher inflation from tariffs will prove transitory, reviving memories of the Fed's slow response to inflation coming out of the pandemic.
Treasury Secretary Scott Bessent also said earlier this month that Fed officials should treat tariff-related price increases like they did at first in 2021 — as "transitory."
"I would hope that the failed 'team transitory' could get back together and think that nothing is more transitory than tariffs," Bessent said in a March 6 speech.
Musalem said Wednesday that he does see the "direct effects" of tariffs as one-time price-level increases that should not have a "persistent" impact on inflation.
Federal Reserve Chair Jerome Powell speaking at a press conference on March 19. (Reuters/Nathan Howard) ·REUTERS / Reuters
But the indirect, second-round effects on nonimported goods and services are those that he said could have a more persistent impact on underlying inflation.
Musalem offered the example of beer from Canada. If it is subject to a 25% tariff, US consumers could shift from Canadian beer to American-made Budweiser, and then Budweiser could increase its prices as people look for locally produced goods.
"Distinguishing, especially in real time, between direct, indirect, and second-round effects entails considerable uncertainty," he added.
If medium- to longer-term inflation expectations begin to increase actual inflation, then in Musalem's view, maintaining the current level on rates for longer is appropriate, and a "more restrictive policy may need to be considered."
"From the standpoint of monetary policy, it could be appropriate to 'look through' direct effects of higher tariffs on the price level and at the same time 'lean against' indirect and second-round effects."
Other Fed officials are wrestling with the uncertainties surrounding Trump's economic policies and what they could mean for inflation.
New York Fed president John Williams said on Friday it's unclear whether the effects will prove to be transitory this time around, noting that it really depends on the different circumstances and the details.
"Tariff direct effects might be short-lived, but we have to be looking at more at what's happening in the economy ... and kind of adjusting our view on the path of policy based on what we're learning along the way," Williams told Yahoo Finance during a media availability on Friday.
Federal Reserve governor Adriana Kugler said Tuesday that she is in favor of holding interest rates steady for "some time" as progress on inflation slows.
The Fed's rate-setting committee "can react to new developments by holding at the current rate for some time as we closely monitor incoming data and the cumulative effects of new policies,” she said in a speech in Washington, D.C., citing a "heightened level of uncertainty."
Musalem said Wednesday that the risks that inflation will stall above 2% or move higher in the near term appear to have increased, referencing consumer surveys showing heightened inflation expectations.
He cited research from staff at the St. Louis Fed who simulated what the effect would be if a 10% tariff were fully implemented — roughly the increase that would be associated with tariff hikes announced to date.
The staffers found that it could increase inflation as measured by the Fed's preferred inflation gauge — the core Personal Consumption Expenditures index — by as much as 1.2%.
"The stakes are potentially higher than they would be if inflation were at or below target, and if consumers and businesses had not recently experienced high inflation, raising their sensitivity to it," Musalem said.
At the same time, Musalem said measures of economic policy uncertainty have risen to levels that could pose some downside risk to the outlook.
Musalem is hearing from his district that the pace of consumer spending appears to have moderated in the first two months of the year and estimates of first quarter real GDP growth have been tracking lower.
That could rebound as the weather warms up, but recent consumer sentiment surveys showing that consumers have grown dissatisfied could weigh on spending, he added.
At the same time, he noted reports of growing caution among businesses, with many commenting that uncertainty about tariffs and other economic policies and their likely effects have made planning difficult.
"Until there is more clarity, many businesses have adopted a wait-and-see posture rather than going forward with significant new hiring or fixed investment," he said.
