OPINION:
Federal Reserve Chairman Jerome Powell is in a tough spot on inflation and unemployment.
Like a goalkeeper facing a penalty kick, he can’t wait to see the direction his opponent drives the ball. He guesses left or right, because the projectile travels faster than he can react.
Monetary policy works with long lags. Mr. Powell must choose between combating inflation and combating unemployment, given that President Trump’s tariffs could make either — likely both — worse.
Mr. Powell believes he can wait to see what develops. This hesitation won’t serve his legacy well.
Mr. Trump’s squandered inheritance
President Joe Biden bequeathed a robust economy with falling inflation.
Back in January, before Mr. Trump unveiled his tariffs, economists expected 2% growth for this year and inflation continuing to fall toward the Fed’s 2% goal — a unicorn-like soft landing.
First quarter GDP growth was -0.2%, because in March imports surged to beat Mr. Trump’s impending tariffs. That weighed heavily in calculations, but domestic demand and employment remained strong.
If we have another poor quarter, it will only be partially caused by another surge in May and June imports, as retailers stock up during a cooling-off period for tariffs on Chinese imports.
Uncertainty about future tariffs is weighing on investment and hiring decisions. Those are slowing economic activity and wage growth, and the 13.9% increase in the average tax on imports is too much for retailers to bear.
Walmart’s announced plans to raise prices provides an umbrella for other stores to move ahead. Higher prices will come across categories of goods with varying lags as retailers run down inventories imported at pre-tariff prices at different rates — but inflation, which was 2.3% in April, likely will be a percentage point higher by next year.
Overall, Trump’s tariffs court stagflation.
Mr. Trump’s sequencing problem
The president’s economic message sounds a bit like Mr. Biden’s. The former commander in chief asked Americans to endure inflation imposed by bigger budget deficits to finance industrial policies. Now Mr. Trump seeks the same goal — reshoring manufacturing to create better jobs — but with high tariffs instead of Mr. Biden’s subsidies to instigate inflation.
Mr. Trump’s additional tax cuts and spending on defense and border enforcement will overwhelm the new revenue collected from higher tariffs to boost aggregate demand and employment, but that’s next year.
This year, Mr. Trump’s policies will impose more inflation, slower growth and a tougher jobs market for the unemployed.
Search times for unemployed white-collar workers have lengthened as they confront the double whammy of businesses nervous about the future and eager to deploy artificial intelligence to replace a growing range of workers.
The power of pessimism
Like most economists, the Fed puts a lot of stock in expectations.
What people believe will happen governs their spending decisions and wage demands to the extent they have leverage when negotiating compensation.
According to the May University of Michigan Survey, consumer sentiment about the outlook for the economy is lower than a snake’s belly, and it pegs inflation over the next year at 6.6%.
Mr. Powell, the goalkeeper, faces twin kickers shooting at opposite corners of the net.
The history of these things teaches that it’s better to take your medicine, conquer inflation by keeping interest rates higher for longer and accept more temporary unemployment as a necessary sacrifice.
An International Monetary Fund study of more than 100 episodes with inflation across 56 countries indicates when central banks prioritize curbing inflation in the near term, their economies suffered no loss in growth or real wages over the next five years.
Foreign investor confidence
The Fed must be conscious of the credibility of Treasurys in international bond markets, because the federal government relies on foreign investors to finance a considerable portion of the national debt. Asian private investors have a particular appetite for dollar-denominated securities, as do those in the U.K.
In contrast to central banks holding Treasurys as reserve assets, private investors are more sensitive to whether the Fed is serious about defending the dollar as a secure store of value by not bending to near-term pressure from Mr. Trump to lower interest rates.
European governments will be borrowing more to finance their defense buildup. Hence, the Treasury will face more competition for the available pool of private savings from euro-denominated sovereign debt.
The dollar is considerably overvalued as measured by purchasing power parity exchange rates — exchange rates for the dollar that would equate prices in U.S. markets to those in the domestic markets of other currencies.
Fed vacillation on curbing inflation could easily result in a bond buyer’s strike and run on the dollar given the persistence of federal deficits close to 7% of GDP.
Fed policymakers should be clear that faced with a choice between fighting inflation and combating rising unemployment, they will prioritize price stability to ensure a better future and accept some short-term unemployment as the necessary price of Mr. Trump’s trade war.
• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.
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