Fed Governor Christopher Waller (voting FOMC member) gives two different tariff scenarios; sees rate cuts in both scenarios
- In terms of output growth, with large tariff increases, I would expect the U.S. economy to slow significantly later this year and this slower pace to continue into next year. Higher prices from tariffs would reduce spending, and uncertainty about the pace of spending would deter business investment. I have heard this repeatedly from business contacts around the country—tariff uncertainty is freezing capital spending. Productivity growth, an important source of GDP increases in recent years, would slow as investment is allocated according to trade policy and not towards its most productive and profitable uses. A fall in productivity would likely lower estimates of the neutral policy rate, making the current policy rate more restrictive than it is currently. Any trade retaliation from U.S. trading partners would reduce U.S. exports, which would be a drag on growth. There is a long list of factors that can lower growth in this scenario.
- Along with slower economic growth would come higher unemployment. With large tariffs remaining in place, I expect the unemployment rate, which was 4.2 percent in March, would rise by several tenths of a percentage point this year and approach 5 percent next year. Even as the economy has moderated over the past year, the unemployment rate has stayed remarkably stable and close to estimates of its long-term rate—in other words, close to the FOMC's goal. But a verifiable fact about the unemployment rate, based on history, is that when it starts to rise, as I expect it would under this scenario, it often rises significantly.
- 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. In my February speech, I referred to this as the world of "bad news" rate cuts. With a rapidly slowing economy, even if inflation is running well above 2 percent, I expect the risk of recession would outweigh the risk of escalating inflation, especially if the effects of tariffs in raising inflation are expected to be short lived.
- Let me now turn to the second scenario, in which tariffs are lower. In this case, I would expect the 10 percent across-the-board tariff to be the baseline for the average trade weighted tariff. Under this scenario the effect on inflation would be significantly smaller than if larger tariffs remained. Here, the peak effect on inflation could be around 3 percent 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. As trade negotiations proceed, I would expect that expectations of future inflation would remain anchored and short-term measures could even fall over time, helping keep overall inflation in check.
- As a result of these limited effects on inflation and economic activity from steadily diminishing tariffs, I would support a limited monetary policy response. Anchored or even lower inflation expectations as the economy slows, combined with the view that smaller tariff effects are temporary, gives the FOMC room to adjust policy as progress on the underlying trend in inflation is revealed in price data. With the threat of a sharp slowdown or recession diminished, pressure to reduce rates based on falling demand would diminish also. That is, the policy response in this scenario could allow for more patience. The preemptive policy cuts we did last fall can allow us some time to wait and see if the hard data catch up to the soft data or vice versa and how much of the tariff will be passed through to the consumer. In such a scenario, the outlook for monetary policy might not look much different than it did before March. With a fairly small tariff effect on inflation, I would expect inflation to continue on its path down towards our 2 percent target. In this case, "good news" rate cuts are very much on the table in the latter half of this year.