Williams ups his inflation and unemployment forecasts.
Uncertain Over Uncertainty
John Williams gave a good speech today on Uncertain Times
To start, I’ll say that the economy entered the year on firm footing. This was a result of strong growth fueled by robust gains in the labor force and productivity. After a period of cooling, a wide range of labor market indicators, including the unemployment rate, have stabilized at levels consistent with a solid labor market.
On the inflation front, the disinflationary process has been on a path toward the FOMC’s longer-run inflation goal of 2 percent. Based on the 12-month change in the personal consumption expenditures price index, inflation was 2-1/2 percent in February, reflecting a broad-based deceleration over the past few years. This is tremendous progress given that in mid-2022, inflation reached a 40-year high of over 7 percent. But we are still not at our 2 percent goal, and I remain committed to bringing inflation back to that goal on a sustained basis.
Understanding Uncertainty
Despite this strong start, the future is highly uncertain. I am not alone in saying this. In fact, “uncertainty” was the overwhelming theme in the latest Federal Reserve Beige Book, a report about economic conditions across the 12 Federal Reserve Districts. Measures of policy uncertainty have increased sharply in recent months. For example, between October of last year and this March, the Economic Policy Uncertainty Index has nearly tripled, reaching the highest level recorded over the past 40 years, outside of 2020. Unsurprisingly, the Trade Policy Uncertainty Index has skyrocketed to levels never before seen in data going back 65 years.
Shifts in sentiment can occur for a multitude of reasons, so understanding their source is key. While uncertainty about the economic outlook reflects many factors, the effects of tariffs and trade policy on the economy are certainly at the top of the list. For example, my business and financial market contacts highlighted that this has made it more difficult to plan for investments and hiring.
This gives us insight into the reality that businesses and consumers are faced with, many of whom speak of taking a wait-and-see approach. It’s a concept economists call the “option value of waiting.” At times of great uncertainty, consumers may put off making big decisions like buying a home or car, and businesses may delay investing until they have a better sense of what the future holds. And when households and businesses cut back on spending, economic growth slows.
Inflation Expectations
In addition to the effects of uncertainty and trade policy on sentiment, we are seeing increasing signs of effects on near-term expectations of inflation. For example, market-based measures of inflation expectations—which reflect what investors are willing to pay to be protected against inflation—have risen at shorter horizons but have remained stable at longer horizons. New York Fed surveys indicate that Second District businesses expect higher cost increases, particularly among manufacturing firms and businesses that rely heavily on imported goods and products. While year-ahead inflation expectations of firms also moved up, their longer-term expectations remained stable.
During times of turbulence and uncertainty such as these, well-anchored longer-run inflation expectations are critically important for ensuring sustained price stability.
Monetary Policy Amid High Uncertainty
Considering the high degree of uncertainty about what the future holds, another question often asked is what this means for monetary policy.
The answer is that the current modestly restrictive stance of monetary policy is entirely appropriate given the solid labor market and inflation still above our 2 percent goal. Importantly, it gives us the opportunity to assess incoming data and developments, and ultimately positions us well to adjust to changing circumstances that affect the achievement of our dual mandate goals.
The Economic Outlook
It’s hard to know with any precision how the economy will evolve. Given the uncertain effects of recently announced tariffs and other policy changes, there is an unusually wide range of outcomes that could transpire. That said, the broad contours of the outlook are becoming a bit clearer.
Given the combination of the slowdown in labor force growth due to reduced immigration and the combined effects of uncertainty and tariffs, I now expect real GDP growth will slow considerably from last year’s pace, likely to somewhat below 1 percent. With this downshift in the pace of growth, I expect the unemployment rate to rise from its current level of 4.2 percent to between 4-1/2 and 5 percent over the next year. I expect increased tariffs to boost inflation this year to somewhere between 3-1/2 and 4 percent.
Inflation Expectation Nonsense
The Fed’s own studies show Inflation expectations are proven nonsense, primarily because most purchases are inelastic.
We did see some tariff avoidance maneuvers, but that results in a self-correcting inventory build that can even backfire.
Williams Playing Politics?
What’s with “I’ll say that the economy entered the year on firm footing.”
One might construe that as accurate, a blast at Trump, or door number 3 which is “Don’t blame the Fed”.
The Case for Wait and See
No one can say with any degree of certainty what Trump will so. He could usher in a deflationary crash or a massive dose of stagflation.
Those are not equally likely, but it does mean there’s a good case for a policy of wait and see (presuming there is a Fed).
However, the Fed is a serial bubble blower and we should get rid of it in a responsible manner, not by letting Trump or any other politician set policy. The one thing worse than an independent Fed is a Fed controlled by politicians.
For now, we are stuck with a Fed. And the more uncertain one is, the more it makes sense to wait for what Trump does, then assess the damage.
Expect Higher Prices
On February 10, 2025 I commented Trump to Impose 25 Percent Tariffs on Steel and Aluminum, Expect Higher Prices
All US consumers of steel and aluminum will pay higher prices, especially the automakers.
The reinstitution of aluminum and steel tariffs across the board is in direct violation of Trump’s loudly bragged USMCA “Best Trade Deal in History”.
Michigan’s Economy Will Be the First Big Loser of Tariff Madness
On April 6, I noted Michigan’s Economy Will Be the First Big Loser of Tariff Madness
Nearly 20 Percent of Michigan’s economy is directly or indirectly related to autos.
April 11, 2025: Tariff-Related Auto Price Increases Have Arrived, Will Get Much Worse
New Car Prices Are Ticking Up. Sales “Hangover” is Likely as Trade Wars Heat Up.
For more on inflation expectations, please see Consumer Sentiment Dives to Lowest Level Since 2022 as Inflation Expectations Jump
It’s a good thing inflation expectations don’t matter.