MNI INTERVIEW: Tariff Inflation To Sideline Fed-Ex CEA Econ

The Federal Reserve is likely to keep rates on hold this year as tariff-related inflation pressures make it harder to justify fresh rate cuts unless growth weakens substantially, former White House Council of Economic Advisers chief economist Ernest Tedeschi told MNI. 

“The Fed, which just a couple of months ago was optimistic that a soft landing was potentially in the cards, is now going to be a basket case for the potential of re-accelerating inflation,” Tedeschi said in an interview. 

“It’s really hard for me to see them going through with their two cuts this year, unless we saw a substantial weakening in the economy.”

The Fed’s March Summary of Economic Projections released last week showed policymakers penciling in a median two rate cuts for 2025, with Chair Powell saying the central bank’s baseline is for the tariff shock to be transitory but noting an unusually high degree of uncertainty around forecasts. 

The Fed “can say that this is a one-time price level shock that they're going to look through, and it shouldn't affect the forecast. In reality, the data are going to be so much messier,” said Tedeschi, director of economics at The Budget Lab at Yale. 

Whether the hit from tariffs is a one-time shock to the price level depends on how they are implemented. If they are simply used as a negotiating tactic and eventually most are taken off or carved out, then their effect on price pressures would be fleeting, he said. 

His models show that if just the current 20% tariffs on China stay in effect while the threats to Canada, Mexico and Europe are nullified, PCE inflation would only be a tenth of percentage point higher over the year. However, a more fulsome implementation that includes reciprocal tariffs could boost inflation by as much as a full percentage point for 2025. 

“That is not a margin of error noise, that is a substantial increase in the price level.”

GROWTH RISKS

Adding to the Fed’s difficulties will be the need to stay attuned to data on the growth side of the economy in order to see how much of a drag will come from policy uncertainty not only on trade but also immigration and federal government cuts. (See MNI INTERVIEW: Fed Backing Away From 2025 Cuts, Says Lacker)

“If this reciprocal tariff idea actually has legs and is as broad as they’re hinting, it might be that could have a real impact on both PCE and growth,” said Tedeschi. 

Worries about a possible recession are premature given that the Trump administration came into office with growth already at elevated levels around 3%, even if there was already some weakness around consumer spending. 

“We don't have a lot of real data that have changed yet – it's mostly sentiment and projections. It is clearly the case that optimism about the economy has fractured,” he said. 

“What was priced in markets was that he was bluffing and that he was not actually going to go through with [tariffs], which was a fundamental miscalculation of how things are different this time around.”

R-STAR 

Even if growth does soften enough to eventually tamp down inflation again and allow the Fed to resume rate reductions, Tedeschi argues that a higher neutral level of interest rates limits how much further they can go anyway. (See MNI INTERVIEW: Fed Must Dampen Stagflation ‘Vibes’ - Roberts)

“Coming into this year, we had 3% growth over the last two years on average. R-star had to have risen if R-star means anything,” he said. “Probably a year ago, I thought maybe it had risen to 1% or so. By the end of last year, I was more convinced it was closer to 2%.”

That would leave the nominal neutral fed funds rate around 4% – not far from the current federal funds range of 4.25-4.5% that the FOMC maintained last week.