By Nick Timiraos
March 5, 2025
Stagflation has entered the chat.
President Trump’s decision to dramatically raise tariffs on imports threatens the U.S. with an uncomfortable combination of weaker or even stagnant growth and higher prices—sometimes called “stagflation.”
The U.S. has imposed 25% tariffs on Mexico and Canada, and another 10% hike on China following last month’s 10% increase. They “will be wildly disruptive to business investment plans,” said Ray Farris, chief economist at Prudential PLC. “They will be inflationary, so they will be a shock to real household income just as household income growth is slowing because of slower employment and wage gains,” he said.
Photo: Brandon Bell/Getty Images
It is still unclear how long Trump intends to keep the tariffs in place. Commerce Secretary Howard Lutnick suggested Tuesday afternoon on Fox Business that a rollback could be in the works.
Some economists said if they stay, then the odds of recession will meaningfully rise.
“This thing could get off the rails pretty quickly,” said Tim Mahedy, chief economist at Access/Macro. “This is not at the level of the 1970s or 1980s. But it does have a whiff of stagflation, or a ministagcession.”
Sentiment indicators and business commentary in recent weeks point to slumping confidence over the threat of higher prices.
China and Mexico are the top two sources of consumer electronics sold at the retailer Best Buy, Chief Executive Corie Barry told analysts Tuesday. “We expect our vendors across our entire assortment will pass along some level of tariff costs to retailers, making price increases for American consumers highly likely,” Barry said. The company’s shares plummeted 13% in the midst of a general stock-market retreat.
Brothers International Food Holdings, based in Rochester, N.Y., imports mangoes and avocados from Mexico and sells fruit juices, purées and frozen-food concentrates to food and beverage manufacturers. New tariffs are forcing the 95-person company to pass on price increases to its customers or accept lower profit margins.
Many of the company’s customers accelerated shipments in January in anticipation of tariffs. “We are bracing for softer sales in the coming months,” said Chief Operating Officer Jack Whittier.
Trump and his advisers have said some short-term pain might be warranted to achieve the administration’s long-term ambitions of remaking the U.S. economy. They have also said their steps to boost energy production could offset higher goods prices.
Nonetheless, tariffs are a particularly difficult economic threat for the Federal Reserve to address. Its mandate is to keep inflation low and stable while maintaining a healthy labor market. Tariffs represent a “supply shock” that both raises inflation, which calls for higher interest rates, and hurts employment, which calls for lower rates. The Fed would have to choose which threat to emphasize.
Fed officials thought they might have engineered a soft landing over the past 18 months. A few are publicly warning of a stagflationary scenario.
“A deterioration of the labor market alongside higher inflation could present difficult choices,” said St. Louis Fed President Alberto Musalem at an economics conference in Washington on Monday.
New York Fed President John Williams said Tuesday at an event hosted by Bloomberg that he expected tariffs would lead to higher inflation this year than he had anticipated. Tariffs on consumer goods, he said, “filter into prices that consumers pay. That happens relatively soon.” Tariffs on intermediate goods, meanwhile, take longer to show up but last longer, he said.
Core inflation, which excludes volatile food and energy prices, has been falling steadily from its 2022 peak of 5.6%, to 2.6% in January, using the Fed’s preferred inflation gauge. That is still above the central bank’s 2% target.
Researchers at the Boston Fed estimate that lifting tariffs on Canada and Mexico by 25% and on China by 10% could add 0.5 to 0.8 percentage point to core inflation depending on the response of U.S. importers. They don’t account for consumers’ substituting cheaper domestic goods, retaliation or fluctuations in exchange rates.
“We won’t get as much of an inflationary bump if the economy contracts, but we also probably won’t get much cooling either. That’s going to hamstring the Fed,” said Mahedy, who previously worked at the San Francisco Fed.
Because monetary policy is also often guided by backward-looking data, worries about inflation in a slowing economy mean “the stars are aligned for a late monetary policy response,” said Mahedy. By contrast, the Fed acted to pre-empt weakness during the 2019 trade war, which it had the luxury of doing because inflation was low.
Fed officials consider expectations a key driver of future inflation, and some measures have hinted at trouble. A survey by the University of Michigan, and Treasury inflation-protected securities, suggest that consumers and investors alike anticipate somewhat higher inflation over the next several years.
“It’s not a good sign for the central bank, and I would think it would be of some concern for the administration,” said Dean Maki, chief economist at the hedge fund Point72 Asset Management.
High inflation or rising long-term inflation expectations would make it harder for officials to justify lower rates. “The stakes are potentially higher than they would be if inflation were at or below target, and if consumers and businesses had not recently experienced high inflation,” said Musalem.
He pointed to the 1970s, the last time the U.S. had stagflation. The Fed oscillated between hiking rates to combat inflation and then lowering them to combat high unemployment, a “stop-go-stop” policy that “is widely viewed as a failure because neither inflation nor unemployment was satisfactorily contained,” said Musalem.
To be sure, commentators repeatedly warned of stagflation over the past four years, and it never materialized. The idiosyncratic nature of the pandemic inflation—driven by supply-chain disruptions and a burst of government spending—allowed the Fed to raise interest rates rapidly to bring down inflation without a downturn.
When the pandemic inflation first hit in 2021, Fed officials judged that they shouldn’t raise rates much because cost pressures from short-term supply shocks would be transitory (i.e., go away on their own).
A similar argument is being made now about tariffs because, in theory, they too are a transitory supply shock, noted Chicago Fed President Austan Goolsbee. “As soon as I include the word ‘transitory,’ then you should get your dander up precisely because that logic didn’t prove true.”
Goolsbee said that the lessons of Covid would be particularly relevant, “if you get policy shocks that start approaching the magnitude of the things that we saw in Covid.”
Write to Nick Timiraos at Nick.Timiraos@wsj.com
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