The difficult path to 2% inflation

OPINION:

The economy is in a sweet spot, but accomplishing 2% inflation will be tough.

After nervousness about impending tariffs early last year, gross domestic product growth returned to the 2.5% pace achieved during the first Trump and Biden presidencies.

In January, the consumer price index was up just 2.4%. Core inflation, which removes food and energy, was 2.5% and trending downward.

Getting to the Federal Reserve’s 2% target will be challenged by tariffs, stressed labor markets and health care costs.

With Kevin Warsh likely to become chair, Fed policymakers will walk a fine line to appease President Trump’s appetite for lower interest rates and avoid overheating the economy.

Foreign suppliers aren’t absorbing the bulk of the tariffs as Mr. Trump predicted. They are finding new customers elsewhere and don’t have to cut prices to U.S. buyers to keep factories humming.

Studies from the Federal Reserve Bank of New York, Germany’s Kiel Institute for the World Economy and elsewhere indicate U.S. importers and consumers have absorbed about 90% of the tariffs.

Faced with strapped consumers last year, wholesalers and retailers didn’t push all the tariffs paid into consumer prices. Now, businesses such as Levi Strauss, McCormick Spices and Toyota are poised to boost prices, perhaps several times, on clothing, common household products and big-ticket durable goods.

Rising employer contributions to health insurance and wage pressures, where workers are in short supply — as in manufacturing, the building trades and health care — are becoming too much to absorb.

This appears paradoxical. The unemployed face long job searches, yet labor markets are often tight, with businesses responding to surging demand.

The recent abatement in core goods inflation has been supported by a drop in used-car prices, but that can’t continue with new-car prices rising.

Whereas before COVID-19, core goods prices were stagnant or falling and inflation was largely a story about housing, health care and other services, those are now rising about 1% a year.

Services, which account for three-quarters of core inflation, remain hot at 3%.

In January, the economy added 130,000 jobs after accomplishing only 15,000 a month in 2025. Most new positions were concentrated in health care and, until recently, education, with the broader economy in neutral.

With artificial intelligence, employers are pruning where specific tasks can be performed by agents and adding staff only where they must. Walmart still needs more drivers to deliver more online sales.

With tougher deportation and legal immigration policies, net immigration could soon hit zero, and indigenous labor force growth can support only about 25,000 new jobs a month.

About 81% of the prime working-age population, those ages 25 to 54, are employed. That’s near its 82% peak in 2000.

As rapidly expanding activities such as data centers and health care absorb more labor, the rest of the economy must shed workers.

Employers are citing rising wages, apart from health insurance and tariffs, to justify holding the line on hiring and raising prices.

AI is both tyrant and savior. Potentially, it enables a precision dance that reallocates a virtually fixed supply of workers outside health care to accomplish a still strong pace of productivity and economic growth.

AI is not destroying entire occupations; rather, it is reorganizing tasks within workplaces.

Whole job categories, such as coders and accountants, are not disappearing. Individual workers must learn to use AI to scale their productivity, often at their own initiative, or they will be displaced by workers at neighboring desks assisted by AI agents.

Many businesses are simply putting the agents on desks and telling workers to figure it out.

For example, Authentic Brands, which owns Reebok and Champion, is giving employees who review legal documents access to Anthropic’s new AI tool but telling them to continue using incumbent software and methods as they experiment.

In such environments, self-starters will supercharge their productivity, whereas employees who coast along will become obsolete and fall into the abyss of long-term white-collar unemployment.

One-quarter of job seekers have been out of work for more than six months because, in no small measure, it’s tough to get those new skills once outside the laboratory for the AI adaptation that workplaces are becoming.

We shouldn’t constrain students too much from using AI to create shortcuts. They may be acquiring survival skills more often than cheating.

At 4.3%, the unemployment rate is within the range economists consider full employment, but it averaged 3.5% during the first half of 2023.

It has crept up because we aren’t channeling enough young people into training for non-college-degree occupations and haven’t devised meaningful reskilling strategies for the midcareer white-collar unemployed stuck outside the laboratory of the workplace.

Survival instincts and markets will make those things happen, but how quickly will determine whether the labor market executes an exquisite minuet that helps return inflation to 2%.

• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.