'Stagflation' risk puts Federal Reserve in tricky spot as it meets this
week
[March 17, 2025] By
CHRISTOPHER RUGABER
WASHINGTON (AP) — When Federal Reserve officials last met in late
January, things looked pretty good: Hiring was solid. The economy had
just grown at a solid pace in last year's final quarter. And inflation,
while stubborn, had fallen sharply from its peak more than two years
ago.
What a difference seven weeks makes.
As the Fed prepares to meet Tuesday and Wednesday, the central bank and
its chair, Jerome Powell, are potentially headed to a much tougher spot.
Inflation improved last month but is still high and tariffs could push
it higher. At the same time, ongoing tariff threats as well as sharp
cuts to government spending and jobs have tanked consumer and business
confidence, which could weigh on the economy and even push up
unemployment.
The toxic combination of still-high inflation and a weak or stagnant
economy is often referred to as “stagflation,” a term that haunts
central bankers. It is what bedeviled the United States in the 1970s,
when even deep recessions didn't kill inflation.
Stagflation, should it emerge, is hard for the Fed because typically
policymakers would lift rates — or keep them high — to combat inflation.
Yet if unemployment also rises, the Fed would usually cut rates to
reduce borrowing costs and lift growth.
It's not yet clear the economy will sink into stagflation. For now, like
businesses and consumers, the Fed is grappling with a huge amount of
uncertainty surrounding the economic outlook. But even a mild version —
with the unemployment rising from its current low level of 4.1%, while
inflation stayed stuck above the Fed's 2% target — would pose a
challenge for the central bank.
“That’s the tangled web they’re in,” said Esther George, former
president of the Federal Reserve's Kansas City branch. "You have
inflation stickiness on the one hand. At the same time, you’re trying to
look at what impact could this have on the job market, if growth begins
to pull back. So it is a tough scenario for them for sure."
Fed officials will almost certainly keep their key rate unchanged at
their meeting this week. Once the meeting concludes Wednesday, they will
release their latest quarterly economic projections, which will likely
show they expect to cut their rate twice this year — the same as they
projected in December.
The Fed implemented three cuts last year and then signaled at the
January meeting that they were largely on pause until the economic
outlook becomes clearer.
Wall Street investors expect three rate reductions this year, in June,
September, and December, according to futures prices tracked by CME
Fedwatch, in part because they worry an economic slowdown will force
more reductions.
One development likely to unnerve Fed officials is the sharp jump in
inflation expectations this month in the University of Michigan's
consumer sentiment survey. It showed the biggest increase in long-term
inflation expectations since 1993.
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Federal Reserve Chair Jerome Powell speaks during the annual U.S.
Monetary Policy Forum, in New York, Friday, March 7, 2025. (AP
Photo/Richard Drew, File)
 Such expectations — which basically
measure whether Americans are worried inflation will get worse — are
important because they can become self-fulfilling. If businesses and
consumers expect higher costs, they may take steps that push up
inflation, like demanding higher wages, which in turn can force
companies to raise prices to offset higher labor costs.
Some economists caution that the University of Michigan's survey is
preliminary and for now based on only about 400 responses. (The
final version to be released later this month typically includes
about 800.) And financial market measures of inflation expectations,
based on bond prices, have actually declined in recent weeks.
The most recent inflation readings have been mixed. The consumer
price index dropped last week for the first time in five months to
2.8% from 3%, an encouraging change. But the Fed's preferred price
gauge, to be released later this month, is likely to be unchanged.
The jump in inflation expectations is also a problem for the Fed
because officials, including Powell, have said they are willing to
let inflation gradually return to their 2% target in 2027, because
expectations have generally been low. If other measures show
inflation worries rising, the Fed could come under more pressure to
get inflation down more quickly.
“I do worry when I see consumer expectations moving in the opposite
direction,” George said. “I think you just have to keep an eye on
that.”
The last time President Donald Trump imposed tariffs — in 2018 and
2019 — overall inflation didn't rise by much, in part because they
weren't nearly as broad as what he is currently proposing and some
duties, such as those on steel and aluminum, were watered down with
loopholes. Now that Americans have lived through a painful
inflationary episode, they are likely to be more skittish about
rising prices.
Powell referred such concerns in remarks earlier this month. He said
tariffs could just have a one-time impact on prices without causing
ongoing inflation. But that could change “if it turns into a series”
of tariff hikes, he said March 7, or “if the increases are larger,
that would matter."
“What really does matter is what is happening with long-term
inflation expectations,” Powell added.
A week after his comments, those expectations shot higher in the
University of Michigan survey.
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