FED: FOMC Members, Staff Grappled With Stagflation Risks At May Meeting

The May FOMC meeting minutes (link) suggested an upward reassessment to the inflation outlook with downside for growth, which is likely to manifest in June's Summary of Economic Projections, largely on account of the impact of tariffs since the March meeting. The new staff projections may already have been made obsolete by post-meeting developments such as the US-China de-escalation, but as noted in the minutes among FOMC members: "Overall, participants judged that downside risks to employment and economic activity and upside risks to inflation had risen, primarily reflecting the potential effects of tariff increases" meaning the FOMC "might face difficult tradeoffs if inflation proves to be more persistent while the outlooks for growth and employment weaken".

• On growth, "the staff projection for real GDP growth in 2025 and 2026 was weaker than the one prepared for the March meeting, as announced trade policies implied a larger drag on real activity relative to the policies that the staff had assumed in their previous forecast. Trade policies were also expected to lead to slower productivity growth and therefore to reduce potential GDP growth over the next few years. With the drag on demand expected to start earlier and to be larger than the supply response, the output gap was projected to widen significantly over the forecast period. The labor market was expected to weaken substantially, with the unemployment rate forecast moving above the staff's estimate of its natural rate by the end of this year and remaining above the natural rate through 2027."
• On inflation, "The staff's inflation projection was higher than the one prepared for the March meeting. Tariffs were expected to boost inflation markedly this year and to provide a smaller boost in 2026; after that, inflation was projected to decline to 2 percent by 2027."
• Notably, on risks, the staff viewed recession as a fairly high probability scenario though not the base case: "the staff continued to note the large amount of uncertainty surrounding trade policy and other economic policies and now viewed the uncertainty around the projection as elevated relative to the average over the past 20 years. Risks to real activity were seen as skewed to the downside, and the staff viewed the possibility that the economy would enter a recession to be almost as likely as the baseline forecast. The substantial upward revision to the inflation forecast in 2025 was judged to leave the risks around the inflation projection balanced in that year. Thereafter, the staff continued to view the risks around the inflation forecast as skewed to the upside, with recent increases in some measures of inflation expectations raising the possibility that inflation would prove to be more persistent than the baseline projection assumed."