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Policymakers have been debating whether tariffs will lead to a one-time increase in the price level or to a more persistent impact on inflation. The first outcome suggests monetary policy should look through the temporary boost to inflation; the second suggests policy should prioritize keeping inflation expectations anchored. Nonetheless, in the past couple of months, official inflation data (see Figure 1) have indicated renewed progress toward our 2 percent inflation target while underlying demand has appeared solid, revealing only a modest imprint of the effects of tariffs on prices, activity or the labor market. Why hasn’t the trade war shown up yet in the data? I see two likely explanations: The economic effects of the trade war are delayed, or companies are finding ways to avoid the tariffs (or some combination of both).
Figure 2 shows a modest increase in core goods inflation, which could include some effects of tariffs on imported goods, but it also likely includes some impact of companies rapidly building inventories in advance of an expected increase in tariffs.
The real economy has also been resilient despite the high tariff announcements. While measures of sentiment appear to be near the lows of the COVID-19 pandemic (see Figure 3), underlying demand has nonetheless held up better than I expected (see Figure 4).
While inflation has continued slowly trending toward our 2 percent target and activity has held up, the labor market has also cooled gently, with the unemployment rate holding at 4.2 percent (see Figure 5) and unemployment claims not showing a rapid acceleration (see Figure 6).
As noted above, I see two primary explanations for this apparent economic resilience: The effects of the tariffs have not yet been felt but are still coming, or companies are finding ways to avoid the tariffs.
Our outreach to industry contacts suggests many businesses are reluctant to pass on price increases to customers, especially if trade deals could soon emerge and reduce overall tariff rates. Why anger customers unnecessarily if tariff rates may soon come down? In addition, many businesses report having built inventories in anticipation of some tariff increases, and they are now working down those inventories while charging customers based on the prices at which those inventories were acquired. If tariff rates remain high because trade deals do not quickly emerge, those businesses suggest they will then have to pass on price increases to customers.
In addition, we know that the actual applied tariff rates on many imported goods depend on when cargo was loaded onto ships in foreign ports. For example, cargo loaded onto ships in Asia on April 4 was not subject to the reciprocal tariffs, while cargo loaded April 5 was. Cargo coming from Asia can take up to 45 days to make it to U.S. ports and then must be transported to distribution centers and then on to customers. It is possible that goods from Asia subjected to high tariffs are only now making their way to customers. These two factors suggest the economic effects of increased tariffs could merely be delayed.
Markets are remarkable in their ability to find paths around economic barriers, such as sanctions and tariffs, and this tends to increase over time. We have heard from some business contacts that they are rapidly adjusting their supply routes to find lower effective tariff paths. In addition, companies are bringing some goods into the U.S. under favorable terms of the U.S.-Mexico-Canada Agreement. And some sectors have been successful in seeking exemptions from tariffs, such as consumer electronics from China. Indeed, the actual or effective tariff rate based on measures of revenues collected at U.S. ports suggests a paid-tariff rate of closer to 8 percent. Eight percent is still more than three times larger than the average effective tariff rate last year but is far, far smaller than the headline tariff announcements that had generated substantial attention among households, businesses and investors (see Figure 7).
Monetary policy should respond to the actual shock being experienced by the economy, not simply the headline announcement. While the debate of whether tariffs will lead to a one-time increase in the price level or to a more persistent increase in inflation is important, we also must try to determine if that price level increase is merely delayed or is likely to be smaller than what was announced. This is challenging and will take time.
While we gather more evidence on the true tariff shock affecting the economy, I believe we should put more emphasis on the actual inflation and real economic data that we are seeing without committing to an easing policy path in case the effects of tariffs are merely delayed.
In December of last year, I indicated two 25 basis-point cuts to the federal funds rate for 2025 in my submission to the Summary of Economic Projections (Figure 8). I did so because I was unsure if the underlying disinflationary dynamics that we saw in 2024 would continue this year. In March, with tremendous uncertainty about the path for tariffs and little additional clarity on the disinflationary dynamics, I did not change my policy expectations. Since March, we have seen much larger than expected tariffs announced and then modestly pulled back, suggesting that an inflation boost is likely coming. At the same time actual inflation data indicate renewed progress toward our inflation target. These opposing signals have led me to maintain my outlook for two cuts over the remainder of 2025, implying a possible first cut in September, barring some surprising development before then. If we were to cut in September and then the effects of tariffs showed up this fall, I believe we should not be on a preset easing course. If the data called for it, we could hold the policy rate at the new level until we gained greater confidence that inflation was headed back to our target.
