Federal Reserve policymakers cannot count on the notion that tariff-related inflation will be fleeting, and the current interest rate setting is appropriate for an economy facing risks to both sides of the central bank's mandate, St. Louis Fed President Alberto Musalem said Friday.
"Committing now to looking through the inflation impact of tariffs, or to an easing of policy, runs the risk of underestimating the level and persistence of inflation," Musalem said at the Hoover Institution's monetary policy conference.
He sees two equally likely scenarios, one where the expected burst of new inflation proves short-lived, and another where price pressures linger for longer.
"Monetary policy is currently modestly restrictive and, I believe, appropriately so for an economy at full employment with inflation above target and some measures of inflation expectations moving higher," said Musalem. (See MNI POLICY: Fed Force Into Hawkish Stance Despite Growth Risk)
The regional bank president said he is closely watching the effects of the trade war, which he expects will push inflation higher and hurt employment.
"Trade policy changes from the beginning of April are likely to move employment and inflation in opposite directions. Monetary policy can manage the resulting trade-off by weighing the size and persistence of inflation’s deviation from target and that of the employment shortfall," he said.
"An implication of this balanced policy approach is some short-term tolerance of higher inflation to lessen the cost of an employment shortfall, provided that medium- to long-term inflation expectations remain anchored," Musalem added. "Prioritizing well-anchored inflation expectations is crucial to ensure that a policy approach that responds both to inflation deviations from target and to employment shortfalls remains feasible."