Fed's Barr Skeptical About Looking Through Tariff Inflation

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00:00We are currently in a challenging position because the risk to both sides of the FOMC's mandate,

00:06employment and inflation, are elevated. I agree with Chair Powell's succinct view that there is

00:12no risk-free path forward for monetary policy. While inflation has come down a great deal since

00:192021, it is still above our 2% target and is now rising. And although several data points indicate

00:26that the labor market may be roughly in balance, we also know there has been a sharp drop in job

00:32creation since May, which suggests risk to the labor market going forward. The most difficult

00:38circumstances for making monetary policy decisions are when both mandate variables are at risk.

00:45Let me start with inflation. The latest data show that 12-month headline inflation based on personal

00:52consumption expenditures, or PCE, rose again in August to 2.7%. Core PCE inflation, which has

01:00historically been a good guide to future inflation, was 2.9%. After falling from its high of 7.2%

01:09in mid-2022 to 2.3% in April of this year, PCE inflation has been rising since then.

01:17That timing is no coincidence. Research by the Federal Reserve staff and others indicate that the

01:24increase in inflation since April has likely owed largely to the sharp increase in tariffs that kicked

01:30in around that time. There are various measures of the overall level of tariffs. For assessing how

01:36tariffs are affecting inflation, I find it helpful to look at tariff collection relative to imports,

01:42which gives us a measure of the real effective tariff rate paid as goods come into the country.

01:48This rate has risen sharply this year, reaching about 11% in August and is likely to rise further in the

01:56near term. The tariff hikes have boosted core goods inflation and, at the same time, progress on core

02:03services inflation has stalled. I expect that core PCE inflation will end the year over 3%.

02:10The median FOMC participant estimates that headline PCE inflation will not return to our 2% target

02:19until the end of 2027, more than two years from today and six and a half years since inflation

02:25began rising in 2021. This would be the longest period of PCE inflation above 2% since a seven-year

02:33stretch that ended in 1993. I recognize that the economy and the American people have been hit by a

02:41series of unusual economic shocks in recent years. The COVID-19 pandemic and related shutdowns, disrupted

02:50supply chains for goods and labor shortages, higher energy costs from Russia's war on Ukraine, and the sudden

02:58increase in tariffs this year. Even so, after the high inflation Americans have endured, two more years

03:05would be a long time to wait for a return to our target, and that possibility weighs on my judgment for

03:11appropriate monetary policy. I am also concerned about future upside risk to inflation and inflation

03:18expectations. While the immediate effects of tariffs on inflation has been smaller than most economic

03:25forecasters had expected, the inventories built up in anticipation of the tariffs may have had a role in

03:31easing the immediate impact, as have compressed profit margins. While that is good news for inflation,

03:40the corresponding bad news is that firms will eventually run down these inventories and will only be

03:46able to compress margins for a while. Many importers and firms affected by imports are reporting that they are

03:54waiting as long as possible to pass on the costs from tariffs to their customers, mostly by temporarily

04:01reducing profit margins. Normalizing margins over time implies a gradual but longer upward trajectory for

04:09inflation, a pattern of price increases that I fear could convince many consumers that higher inflation

04:16is going to be more of a permanent phenomenon. This is important because expectations of future inflation

04:23affect spending decisions in the near term and can drive a cycle of escalating inflation, as we saw after prices

04:30began rising in 2021. With that experience in mind, I am skeptical of assurances that we should fully look

04:39through higher inflation from import tariffs. While in principle tariffs are a one-time increase in prices and

04:46should not sustainably raise inflation. That may not be the case if prices keep rising month after month

04:53and affect expectations. There's been nothing one-time or predictable about these tariff increases, which have

05:01ratcheted upward this year on particular countries and particular sectors in a series of steps. At some point,

05:08businesses and consumers could start to make pricing, spending, and wage decisions based on their belief in higher

05:15future inflation, thereby driving a cycle of persistence. Measures of near-term expectations are down from peaks in April,

05:24when tariffs were announced, but they are still higher than last year. As a result, I believe the Federal

05:31Federal Reserve's price stability goal faces some significant risks.

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