The Fed Faces Trump’s Tariffs | American Enterprise Institute
By Steven B. Kamin
At its December meeting, the Federal Open Market Committee (FOMC) lowered the target range for the policy interest rate by 25 basis points, to 4.25–4.50 percent, as widely expected by the market. As also expected, the FOMC signalled it expected to continue loosening monetary policy in 2025, albeit through two rate cuts rather than the four cuts it had projected in its September forecast. In his press conference after the meeting, Fed chairman Jay Powell emphasized that since September, data on both inflation and the growth of the economyhave come in somewhat stronger than expected, indicating that less monetary loosening is needed for inflation to be guided down to the Fed’s 2 percent target. This shift to a less dovish policy outlook does not appear to have been a direct response to President-elect Trump’s recent threats to raise tariff rates, although Powell acknowledged that some of the officials contributing to the forecast may have taken into account future policy actions by the administration.
Much of the reason that Powell wanted to deny that the Fed was preparing to tighten policy in response to Trump’s tariff plans (or his fiscal plans) was political — he does not want to draw Trump’s ire, as the Fed did during Trump’s first administration. Nonetheless, from a purely economic policy standpoint, it is also the right thing to do. Monetary policy affects the economy with “long and variable lags,” often judged to be one to two years ahead. So in principle, if hikes in tariffs are expected in 2025 or 2026, the Fed should be adjusting its monetary policy now in order to head off any inflationary impacts of those tariffs.
The problem, of course, is that it is impossible to know whether Trump will actually boost tariffs, when he will do so, against which trading partners, and by how much. This uncertainty makes it very difficult to use monetary policy preemptively in anticipation of his trade policies. If tariffs are not raised substantially in the next year or two, preemptive monetary tightening would risk depressing the economy for no good reason. The best strategy for the Fed to prepare for large tariff hikes is to analyze their likely effects on the economy and the implications for monetary policy, but hold off on taking action until the size, scope, and timing of those hikes become more apparent.
