MNI INTERVIEW: Fed To Focus On Growth Drag From Tariffs - Sahm
MNI (WASHINGTON) - Federal Reserve officials are likely to focus on the growth-dampening effects of sweeping new U.S. tariffs for now, likely penciling in two or three rate cuts in their upcoming March forecast, former Fed board economist Claudia Sahm told MNI.
Policymakers are cognizant of the inflation risks posed by protectionist trade policies but they are also inclined to see any initial shocks as a one-time increase to the price level that policy can “look through,” Sahm said in an interview Tuesday.
“A mixture of two to three cuts across officials looks plausible – but i don’t know necessarily the median will flip,” Sahm said of the March Summary of Economic Projections. The latest SEP in December showed a median of two cuts in 2025.
“We’re on a stagflationary path, a modest one, it’s not the 1970s,” she said, adding that she expects a pickup of about half a percentage point in inflation and policymakers' forecasts will likely reflect this gain.
“It is also the case that we should see some slowing of growth and, even if you set aside the tariffs that have gone into effect, you still have this massive cloud of uncertainty," Sahm said. Still, growth and employment will actually have to weaken notably before the Fed resumes rate cuts after keeping them on hold at 4.25-4.5% in January and likely again later this month, she said.
“What will be decisive in the Fed cutting ... will be that the growth effects are pronounced,” Sahm said. “They’ve got to see that. They’re not going to cut because, 'Oh, this bump in inflation is just tariffs.' There’s going to have to be something in the growth space that motivates them.” (See MNI INTERVIEW: US Downside Worries Grow-Conference Board)
INFLATION BUMP
At the same time, the likely inflation hit from tariffs, even if it proves temporary, will make it harder for the Fed to argue for interest rate reductions in the short run, said Sahm.
“This Fed is one that wants to have data in hand. And it takes time for it to show up in official statistics. Say you really wanted to get past the peak inflation, really know it’s just a price level adjustment. That’s going to be a while. And in all likelihood we are not done with tariffs,” she said. “It is entirely possible that tariff-induced inflation ends up being two-year transitory also."
That would be problematic for officials who are already noting rising inflation expectation in surveys and market measures. “The biggest fundamental driver of inflation expectations is our experience with inflation. So the longer we stay in an elevated inflation environment, the more likely we are to kind of get used to that, build that into contracts, build that into negotiations for wages and other prices. So it does create risk,” Sahm said.
"We've just come out of a period where people have gotten used to prices going up. Businesses have gotten used to being able to raise prices. The longer you stay in that world, the harder it's going to be to get out."
Nonetheless, the Fed in the 2018-2019 trade war saw mostly a growth drag, and it will likely remain inclined to buffet an economy that is already showing some signs of fraying around the edges.
“The economy was probably going to moderate anyway this year and then you have the tariffs that are disruptive and you have the government layoffs that can add up and this maximalist approach to create uncertainty," Sahm said. "A lot of the pro-growth policy changes like tax cuts are further down the road – they’re not even 2025 effects."