MNI: Fed's Waller Calls For 'Flexible' Rates Policy, Sees Cuts

Federal Reserve Governor Christopher Waller on Monday called for "flexible" monetary policy ranging from significantly lowering interest rates when faced with the threat of a recession to holding rates higher for longer in response to how President Trump's tariff policies evolve, while also maintaining his view that the inflationary effects of tariffs are likely to be temporary.

The tariff increases announced April 2 are "one of the biggest shocks to affect the U.S. economy in many decades," yet the future of those policies and their effects are still highly uncertain, Waller said. 

"This makes the outlook also highly uncertain and demands that policymakers remain flexible in considering the wide range of outcomes," he said in remarks prepared for a business society in St. Louis, Mo. 

With a pause on implementing the reciprocal tariffs unveiled April 2 but retaining the minimum 10% across-the-board rate plus over 100% on Chinese imports, the average effective tariff is now around 25%, Waller noted. 

'BAD NEWS' CUTS 

He sketched out two tariffs scenarios and the Fed's potential reaction to each. In a "large tariff" scenario where the administration maintains the 25% rate for some time to fundamentally reorient the U.S. economy toward more manufacturing, "economic growth is likely to slow to a crawl and significantly raise the unemployment rate" to 5% by next year from 4.2% now, necessitating easier monetary policy, he said. 

Inflation could jump to 4%-5% this year but return to a more moderate level next year as long as expectations remain well anchored, he said. That's because monetary policy continues to be restrictive, and businesses who want to hold on to customers may not pass along all their cost increases. Weaker demand from a slowdown will also weigh on inflation, he said. (See: MNI INTERVIEW: Inflation Expectations Surge, Troubling For Fed)

"Despite the fact that the last surge of inflation beginning in 2021 lasted longer than I and other policymakers initially expected, my best judgment is that higher inflation from tariffs will be temporary," Waller said. 

So-called "bad news" rate cuts may be needed in this case, he said. 

"While I expect the inflationary effects of higher tariffs to be temporary, their effects on output and employment could be longer-lasting and an important factor in determining the appropriate stance of monetary policy. If the slowdown is significant and even threatens a recession, then I would expect to favor cutting the FOMC’s policy rate sooner, and to a greater extent than I had previously thought."

GOOD NEWS CUTS

In a "smaller tariff" scenario where the goal is to use tariffs to negotiate better trade deals, Waller said he would assume all but the 10% across-the-board levy to be canceled, resulting in a smaller negative effect on output and employment growth. 

"The peak effect on inflation could be around 3% on an annualized basis. Since it may take some time for tariff-related price
increases to work their way through production chains, the peak may be lower but still dissipate slowly," Waller said. 

"As a result of these limited effects on inflation and economic activity from steadily diminishing tariffs, I would support a limited monetary policy response" that looks little changed from March 1, he said. 

That "gives the FOMC room to adjust policy as progress on the underlying trend in inflation is revealed in price data," and "rate cuts are very much on the table in the latter half of this year," he said.