MNI INTERVIEW: Fed Could Pause As Prices Spike in 2025-Gagnon
MNI (WASHINGTON) - President-elect Donald Trump’s policy proposals to boost tariffs and curb immigration are likely to raise inflation early next year in a way that forces Federal Reserve officials to reconsider their monetary easing path, former Fed economist Joseph Gagnon told MNI.
For the Fed, that could mean a shallower path for rate cuts and even a pause in reductions to assess the situation. However, such a pause would have to be precipitated by actual policy changes rather than speculation, and that might take time, said Gagnon in the latest episode of MNI’s FedSpeak Podcast.
“These inflationary things would cause them to raise the path of the fed funds rate, stop cutting perhaps for a while, wait and see,” he said.
“The Fed doesn’t want to anticipate the policies, but when the policies are announced and seem very likely to be implemented or are implemented they will act. Maybe the March 2025 Summary of Economic Projections is the most likely time when the Fed could really respond to Trump’s policies in terms of changing the path,” Gagnon added, predicting another quarter-point rate cut in December after last week’s cut of the same magnitude. (See MNI INTERVIEW: Fed To Pause, Take Stock In Early 2025-Lockhart)
INFLATION BURST
“We can expect higher tariffs on imports, more deportations of undocumented workers and both of these things are inflationary,” said Gagnon, who has also previously served at the U.S. Treasury and is now a senior fellow at the Peterson Institute for International Economics.
“It both raises inflation and slows growth in the U.S. economy. I think inflation is the first thing that would show up because if you put tariffs on you immediately start seeing higher prices. All the studies I’ve seen show that the previous Trump tariffs were pretty much 100% passed onto consumers. I have no reason to doubt that would still be true.”
That doesn’t mean inflation will head back to the 7-8% levels that prevailed during the post-Covid peak, said Gagnon, though it would still rise appreciably.
“Inflation is heading down to the Fed’s 2% target now. I could easily see it heading back up to 3 or 4% under Donald Trump,” he said.
One caveat is that the Fed could see tariffs or immigration restrictions as a one-time shock that it might be able to look through, though Gagnon said officials might be reluctant to do so given recent experience.
“We’ve just come off an inflationary episode, so the Fed may feel less scope to look through a new burst of inflation.”
FISCAL PROFLIGACY
U.S. fiscal policy has been excessively loose, and the absence of immediate plans for or prospect of bringing down the deficit suggests inflationary pressures – and bond yields – will remain higher than otherwise, said Gagnon.
Still comparisons with places like Greece are overstated, and the United States is more likely to have a default because of government dysfunction than it is to have a classic debt crisis in the emerging market sense, he said.
“It was good to have fiscal stimulus under Covid, but then it’s been way too slow to be reeled back in. Frankly that’s one reason the Fed has needed to raise rates as much as it did and hold them as high as it did for so long - the fiscal was so strong, and higher than it needed to be,” Gagnon said.
“When will it run into a problem? That’s hard to predict. There’s no obvious line in the sand at which things go bad. I think we have a ways to go before markets would seriously be worried.”