The Federal Reserve's dual mandate dilemma
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Illustration: Brendan Lynch/Axios
With the U.S. economy shifting toward stagflation, the central question for the Federal Reserve will be which half gets worse: the stag- or the -flation.
Why it matters: The central bank faces challenges on both sides of its dual mandate — the responsibility to seek both stable prices and maximum employment.
- Fed officials say they will assess on which side of the mandate they are most coming up short.
The big picture: Most forecasters think a recessionary impulse in the economy will be powerful enough (and trade war-driven, inflation-temporary enough) that the Fed's next move will be rate cuts to support the job market — even if those cuts won't come quickly enough for President Trump's taste.
- But Fed officials have avoided committing themselves to that approach, leaving open the possibility that the next move could be a rate hike to combat inflation.
- Indeed, modeling of the trade war's effects points to 2025 inflation being considerably further from the Fed's goals than the unemployment rate.
What they're saying: "We may find ourselves in the challenging scenario in which our dual-mandate goals are in tension," Fed chair Jerome Powell said last week.
- "If that were to occur, we would consider how far the economy is from each goal, and the potentially different time horizons over which those respective gaps would be anticipated to close," he said.
Zoom in: Some simple math shows how those numbers may look by the end of the year.
- The unemployment rate was 4.2% last month, which is also the level that the median Fed official sees as its long-term rate. So the maximum employment mandate is, for the moment, being achieved.
- The Yale Budget Lab estimates that the tariff policies currently in place, if sustained, would raise the unemployment rate by 0.6 percentage point by year-end, which implies a 4.8% jobless rate.
- The impact on inflation would be considerably higher in the Yale group's models, fueling a 1.6 percentage point rise in the price level. That's even after adjusting for "substitution effects," in which activity shifts toward lower-tariff and domestically made goods.
The intrigue: Inflation is already running above the Fed's goals, with the Personal Consumption Expenditures Price Index up 2.5% for the 12 months ended in February.
- Even if you use a more generous baseline, assuming that in a non-trade-war world inflation would be 2% this year, tariffs are on track to push the economy further from the Fed's price stability mandate than its maximum employment mandate, at least temporarily.
Reality check: There's a lot going on aside from trade — particularly a volatile financial market environment, as well as slumping business and consumer confidence — that could change the landscape over the years ahead.
- Moreover, as Powell's quote above indicates, the Fed won't be exclusively using some mechanical analysis of how far it is from each goal, but rather will factor in how persistent those divergences are likely to be.
The bottom line: "Our modeling suggests the Fed should look through" a one-time shift in prices due to tariffs, Martha Gimbel with the Yale Budget Lab tells Axios.
- "But that doesn't account for changes in expectations or contagion from financial markets," she adds. "Expectations are the ballgame right now, and that makes it particularly important that the Fed is able to signal that it's going to keep inflation under control."
