Federal Reserve's Interest Rate Cuts Amid Persistent Inflation: Economic Risks Under Trump Administration

Economists are cautioning that the Federal Reserve's interest rate reduction might be hazardous if prices remain elevated.

Washington:

Inflation has increased in three of the past four months and currently sits slightly higher than it was a year ago, when it contributed to undermining then-Vice President Kamala Harris' presidential campaign. However, this reality isn't reflected in statements from President Donald Trump or even some inflation-fighting officials at the Federal Reserve.

At the United Nations General Assembly recently, Trump proclaimed, "Grocery prices are down, mortgage rates are down, and inflation has been defeated."

Similarly, Federal Reserve Chair Jerome Powell stated in August, before the Fed implemented its first interest rate cut of the year, "Inflation, though still somewhat elevated, has come down a great deal from its post-pandemic highs. Upside risks to inflation have diminished."

Yet minimizing inflation concerns while rates remain above the Fed's 2% target creates significant risks for both the White House and Federal Reserve. The Trump administration may find itself misaligned with public sentiment, as surveys consistently show many Americans still view high prices as a major financial burden.

The Federal Reserve may be taking an even greater risk: It has reduced its key interest rate assuming that Trump administration tariffs will only temporarily increase inflation. If inflation worsens or stays elevated longer than anticipated, the Fed's credibility as an inflation fighter could be seriously compromised.

This credibility is fundamental to the Fed's ability to maintain price stability. When Americans trust the central bank to control inflation, they avoid behaviors like demanding substantially higher wages that can trigger inflationary spirals. Companies often raise prices further to offset increased labor costs.

Karen Dynan, senior fellow at the Peterson Institute for International Economics, warned this week that with pandemic-era inflation still fresh in memory and tariffs increasing imported goods costs, consumers and businesses might begin losing confidence that inflation will remain controlled.

"If that proves to be the case, in hindsight it will be that the Fed cuts -- and I do expect several more -- are going to be seen as a mistake," Dynan noted.

Thus far, Trump administration tariffs haven't elevated inflation as much as many economists predicted earlier in the year. While inflation remains well below its 9.1% peak from three years ago, consumer prices increased 2.9% in August compared to a year earlier, up from 2.6% during the same period last year and exceeding the Fed's 2% target.

The September inflation report was scheduled for Wednesday, though government shutdown complications may delay its release.

Tariffs have increased costs for numerous imported items, including furniture, appliances, and toys. Overall, durable manufactured goods costs rose nearly 2% in August year-over-year. Though modest, this increase follows nearly three decades during which such items' prices generally declined.

Everyday necessities continue rising faster than pre-pandemic rates: Grocery prices increased 2.7% in August compared to a year ago, representing the largest non-pandemic increase since 2015. Coffee prices have surged nearly 21% over the past year, partly due to Trump's 50% import taxes on Brazil, a major coffee exporter, and climate change-induced droughts affecting coffee harvests.

Most Federal Reserve officials remain concerned about elevated inflation, according to minutes from their September meeting. Nevertheless, they opted to cut their key interest rate, prioritizing concerns about potential unemployment increases over inflation risks.

The concern among some economists is that ongoing tariff implementation and continued corporate price increases could result in more than just temporary inflation increases.

"It is a big gamble after what we've been going through ... to count on it being transitory," said Jason Furman, Harvard University economist and former top adviser to President Barack Obama. "Once upon a time, (3% inflation) would have been considered really high."

Two weeks ago, Trump imposed new tariffs on various products, including 100% on pharmaceuticals, 50% on kitchen cabinets and bathroom vanities, and 25% on heavy trucks. Last Friday, he threatened "a massive increase of tariffs" on Chinese imports in response to China's restrictions on rare earth exports.

Companies continue raising prices to offset tariff costs. Duties on steel and aluminum imports have increased can costs for Campbell Soups, leading its CEO to announce in September plans for "surgical pricing initiatives."

Chris Butler, CEO of National Tree Company, America's largest artificial Christmas tree seller, says his company will increase prices approximately 10% this holiday season on trees, wreaths, and garlands to offset tariff costs. About 45% of their trees are manufactured in China, with the remainder from Southeast Asia, Mexico, and other countries. He explains that U.S. labor and real estate costs make domestic production unfeasible.

Butler also anticipates reduced supply of artificial trees and decorations this year, potentially driving industry-wide prices higher, because most Chinese production halted when tariffs reached 145% earlier this year. Production resumed after Trump reduced duties to 30%, but at reduced capacity.

While Butler has urged suppliers to absorb some tariff costs, they won't cover all increases.

"At the end of the day, we can't absorb the entirety of it and our factories can't absorb the entirety of it," he explained. "So we've had to pass along some of the increases to consumers."

Many Fed policymakers recognize these risks. Jeffrey Schmid, Federal Reserve Bank of Kansas City president and voting member on interest rate decisions, said Monday that inflation resulting from reduced confidence in the central bank is more difficult to combat than price increases caused by supply disruptions.

"The Fed must maintain its credibility on inflation," Schmid emphasized. "History has shown that while all inflations are universally disliked, not all inflations are equally costly to fight."

Nevertheless, some Fed officials believe other trends counterbalance tariff impacts. Fed governor Stephen Miran, recently appointed by Trump before September's central bank meeting, stated Tuesday that steadily decreasing rental costs should reduce underlying inflation in coming months. Additionally, he suggested reduced immigration resulting from administration policies will decrease demand, easing inflationary pressures.

"I'm more sanguine about the inflation outlook than a lot of other people are," he concluded.