How will tariffs affect inflation?

This week will be chatty for Fed officials, with remarks scheduled from Federal Reserve bank presidents, governors and others. A topic that’s sure to come up: inflation and how tariffs might affect it. 

In fact, it’s already come up. On Monday, Fed governor Christopher Waller said he thinks tariffs would only modestly increase prices and he favors “looking through these effects when setting monetary policy.” Chicago Fed President Austan Goolsbee — in previous remarks and on “Marketplace” — has warned that tariffs could increase inflation.

At the heart of the debate is the question: Do tariffs lead to one-time price increases, or do they lead to more persistent inflation?

To predict how tariffs might affect inflation, economist Stephanie Kelton at Stony Brook University said we need to know exactly what the tariffs will be.

“It’s so tough because we’re trying to have a conversation about something where there’s just, you know, nobody knows,” she said.

We don’t know if all the proposed tariffs will go through or if they’ll lead to a trade war and more taxes on trade. So first?

“The Fed is going to try to look past that transitory inflation spike that’ll be created by the tariffs,” said Ken Kuttner, a professor at Williams College and a former Fed staffer.

Unless consumers think that price spike is just the beginning. “People start thinking, well the price of tomatoes went up, everything else is going to start going up. So we’re returning to an inflationary environment,” he said.

“Returning” is a key word here. Years of inflation have primed us to think higher tomato prices mean higher prices for cars and clothes. And with tariffs, that might appear to be true, since they cover many categories of goods whose prices will rise kind of all at once.

Randy Kroszner, a former Fed governor, said a sign that workers believe this is inflation would be that they ask for pay raises.

“Typically, the Fed will respond to something that it sees as an ongoing process. You know, if wage increases continue to be very high and that adds to cost of production and that will lead to higher prices down the line,” he said.

It’s why, regardless of where the tariffs land, the Fed’s messaging will be important.

“If the inflation rate starts to move up for whatever reason, the Fed is going to feel compelled to respond in some way,” said Stony Brook’s Kelton.

Maybe with a longer pause in cutting interest rates or even a hike to signal to consumers that it is serious about getting inflation down to 2%.