Fed leaves interest rates unchanged - Inflation and high unemployment increase the risk of stagflation in the US
The Federal Reserve kept its target rate at 4.3% for the third straight meeting, after cutting it three times in a row late last year. Many economists and Wall Street investors still expect the Fed to cut rates this year.
During a press conference after the policy statement was released, Chairman Jerome Powell noted that the tariffs have dampened consumer and business sentiment but have not yet significantly damaged the economy. At the moment, Powell said, there is too much uncertainty to say how the Federal Reserve should respond to the charges.
"If the large rate hikes that have been announced are sustained, they are expected to generate high inflation, slowing economic growth and a rise in unemployment," Powell said. "The impacts could be temporary or more permanent. There are so many things we don't know. We are in a good position to wait and see," he added.
It is unusual for the Federal Reserve to face the risk of higher prices and rising unemployment at the same time. Typically, rising inflation occurs when consumers spend freely and businesses, unable to meet all the resulting demand, raise their prices, as happened after the pandemic. Meanwhile, rising unemployment occurs in a weaker economy, which usually slows spending and reduces inflation.
A combination of higher unemployment and inflation is often called “stagflation” and strikes fear into the hearts of central bankers because it is difficult for them to handle both challenges. This last happened in a sustained manner during the oil shocks and recessions of the 1970s.
However, most economists say Trump's sweeping tariffs pose the threat of stagflation. Import taxes could increase inflation by making imported parts and finished goods more expensive, while also increasing unemployment, forcing companies to cut jobs as their costs rise.
The Federal Reserve's goals are to keep prices stable and maximize employment. Typically, when inflation rises, the Federal Reserve raises interest rates to slow borrowing and spending and reduce inflation. If job losses increase, the Fed will lower interest rates to spur more spending and growth. At the start of the year, analysts and investors expected the Federal Reserve to cut its benchmark rate two or three times this year as the inflation surge that followed the pandemic continued to subside.
Some economists also think the Fed should cut interest rates in anticipation of slower growth and worsening unemployment from tariffs. But Powell is confident that, with the economy in good shape right now, there is no need for change.
A few months ago, many analysts also expected the economy to reach a "soft landing," in which inflation would finally fall back to its 2% target, while unemployment would remain low amid strong growth.
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