Shoppers walk along 5th Avenue on Black Friday in New York City on November 25, 2022. Credit: Jeenah Moon/Bloomberg.
If President Donald Trump’s tariffs jack up U.S. consumer prices—as pretty much everyone thinks they will, at least for a while—then that’s already bad news for inflation fighters at the Federal Reserve. It could also open the door to something even worse.
What businesses and workers anticipate will happen to prices, economists say, can play a key role in determining what actually does happen. That’s why Fed officials always keep a close eye on estimates of future inflation—and the latest ones show cause for concern. The benchmark gauge of long-run expectations for inflation, which had already climbed to a 30-year high since Trump’s election, soared higher still on Friday after his sweeping global tariffs took effect.
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That kind of mindset could help turn a one-time price hit from Trump’s trade war into a more persistent inflationary impulse. The risk is all the greater because it’s surfacing at a time when American households are still shaken by post-pandemic price increases and may not trust the Fed to head off another bout of inflation. Consumer and business estimates of future inflation open a window into the public’s faith in central banks’ ability to tame prices. When that erodes, especially over the longer run, monetary theory suggests that policy becomes less efficient. In concrete terms, interest rates have to go higher than they would otherwise need to, until trust is regained.
A sharp rise in long-term inflation expectations would signal a loss of faith in the Fed’s ability to bring inflation back to 2 percent. “That would worry me,” says Jeffrey Fuhrer, a former director of research at the Boston Fed who’s now with the Brookings Institution. To be sure, that’s not what most surveys are pointing to. But even without an erosion of trust on that scale, a trade war could make the Fed’s job harder, Fuhrer says. If consumers face tariff-led price hikes well above 3 percent over the next year, they may decide that’s the new normal and build it into their everyday calculations. Workers would demand higher wages while firms adapt their pricing plans. “Then we have a problem,” he says. “And we don’t need that problem right now.”
The key measures of U.S. inflation, as of March, stood around 2.5 percent, far below their 2022 peaks but still stubbornly above target. Most economists expect a pickup in the coming months, as tariffs make imported goods more expensive.
Consumers in the latest University of Michigan survey are expressing the same concern. They expect prices to rise 6.7 percent in the coming year, and at an annual rate of 4.4 percent over a 5- to 10-year horizon. In both cases, these expectations represent multi-decade highs. Although some economists question Michigan’s methodology, The Conference Board’s year-ahead gauge also surged since December.
Other datasets paint a less alarming picture. Market measures such as 5- and 10-year breakevens based on Treasury bonds are hovering around the Fed’s 2 percent goal. The latest New York Fed Survey of Consumer Expectations, for February, showed three- and five-year inflation estimates unaffected by trade war fallout, at around 3 percent. That’s prompted Fed Chair Jerome Powell to say the Michigan results are an “outlier.”
Still, Powell and his colleagues are watching inflation expectations closely as they try to map a path through the trade war. “One of the very important assets that the Federal Reserve has is its credibility, and that is manifested in anchored longer-term inflation expectations,” Boston Fed President Susan Collins told Yahoo Finance on Friday. She also said the tariff impact will likely be “more broad-based than many people realize.”
Fed officials had already revised growth estimates down, and inflation up, before Trump’s tariff announcements this month. Since the announcements, a number of Fed officials have warned that consumer prices could rise around 4 percent this year. It’s given policymakers reasons to refrain from rate cuts—even as fears of an economic slowdown mount—and instead hold borrowing costs steady.
Consumers’ Confidence in the Fed Is ‘Deeply Wounded’
Until the past few years, U.S. inflation had been stable enough for long enough—essentially since the early 1990s—to keep future expectations in check. But the price shock that followed the pandemic and the war in Ukraine has changed the picture. It’s turned inflation into front-page news, and that’s feeding through into the forward-looking gauges. American consumers “have yet to really recover,” says Joseph Brusuelas, chief economist at RSM U.S. LLP. They’re responding to inflation surveys “in such a way that speaks to their current mindset—which is, they remain deeply wounded.”
Of course, there’s no automatic link from expected to actual price increases. That’s especially true in the United States, where built-in inflation indexing for labor contracts or rents is less common than in many other countries. Some economists have questioned whether price expectations really contain much useful information. Still, the consensus is that they do—and that’s based on research that stretches across history and around the world.
Michael Weber, a professor at the University of Chicago, has studied the fallout from Germany’s hyperinflation after World War I. Even though a century has passed, he found that people in towns with higher inflation back then are still prone to have higher expectations for prices today, and their local politicians are more likely to talk about it. For central bankers, too, past experience with inflation can shape their approach in the present. Lately, some Fed officials who’ve publicly voiced concern over the expectation surveys are those with an international background or with links to high-inflation countries in Latin America. “Even if you are a central banker, the weight you put on inflation depends on your upbringing, where you’re from,” Weber says.
All the accumulated experience from countries that are more accustomed to inflation shocks holds some valuable lessons for Powell and peers, according to Ricardo Reis of the London School of Economics. Among them: Look at a wide range of measures, grasp that above-target expectations can result in lasting shocks, and take swift action when needed. Reis says the pandemic price spike has been a useful reminder to developed-world central banks of the importance of inflation expectations as a mirror of their own credibility. “Ignoring them, talking about transitory things, pretending the problem is not there, is not what you should do,” he says.
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