In a recent speech delivered in Seoul, South Korea, Federal Reserve Governor Waller offered unique insights into how monetary policymakers should think about the effects of tariffs on both inflation and inflation expectations. His remarks come at a time when trade policy is once again at the center of national debate, and concerns about inflation remain top of mind for households, firms, and policymakers alike.
Waller focused on three key areas: the immediate inflationary effects of tariffs, why those effects are unlikely to persist, and the divergence between household inflation expectations and market-based measures.
To frame his discussion on tariffs and inflation, Waller revisited the two tariff scenarios he introduced earlier this year: one large and one small. In both cases, he assumed — consistent with standard economic theory — that the tariffs would lead to a one-time increase in the price level, temporarily raising the inflation rate as the economy transitions to a higher price path. Once this adjustment occurs, Waller explained, inflation should return to its underlying trend, based on his view that longer-term inflation expectations remain anchored.
In Waller’s large tariff scenario, he assumed that the trade-weighted tariff on goods imports would be 25 percent, which, he noted, was not far off from where things stood following the 90-day suspension the administration announced on April 9. In this scenario, Waller assumed the tariff would remain in effect for some time, which he predicted would lead to inflation — as measured by the personal consumption expenditures (PCE) price index — peaking at around 5 percent annualized later this year, assuming firms passed through the full tariff to consumers. If, on the other hand, firms passed on only part of the tariff, he projected inflation would peak at around four percent. Regardless of the degree of pass-through, Waller believed that the unemployment rate would rise to 5 percent in 2026 under the large tariff scenario.
In his small tariff scenario, Waller assumed a 10 percent tariff on goods imports that would remain in place indefinitely, with higher country- and sector-specific tariffs falling over time as the administration negotiated trade deals. In this case, Waller predicted that inflation might rise to an annualized rate of three percent but, as before, would eventually return to trend. While output growth would slow, Waller thought it unlikely that unemployment would rise, as it would under the large tariff scenario.
Given recent developments in trade negotiations, Waller noted that his base case for tariffs is a 15 percent rate on goods imports — splitting the difference between his large and small scenarios. In his view, the likelihood of the large tariff scenario has fallen, given the administration’s recent negotiations. He noted, however, that there remains significant uncertainty about the ultimate outcome of the administration’s trade policy, making it difficult to know exactly what the economic outlook will be.
Making matters more uncertain is the divergence between “hard” and “soft” data on the tariffs’ effects. Waller observed that the hard economic data so far is generally positive, showing little evidence that tariffs have meaningfully affected inflation or overall economic activity. By contrast, surveys of households, firms, and investors point to slower growth and higher prices. Waller appears to share those concerns, noting that he sees downside risks to both sides of the Federal Reserve’s dual mandate in the second half of this year — especially on the employment side, as tariffs are likely to reduce spending and prompt firms to cut payrolls. He emphasized, however, that these risks will depend on how the administration’s trade policies evolve in the coming months.
On the price-stability side of the mandate, Waller noted that before the recent upheaval in US trade policy, the Fed had been making progress — albeit uneven — toward bringing inflation back down to its 2-percent target. Waller now expects that tariffs will push inflation higher later this year, but observed that the surge in imports earlier this year makes the precise timing of that increase difficult to predict. Nonetheless, whatever effect the tariffs have on inflation, Waller expects it will be temporary. The size of the rise, he emphasized, will depend not only on the ultimate scale of the tariffs, but also on how both importers and exporters respond — something that remains highly uncertain.
One aspect of that uncertainty is the extent to which firms will pass on the cost of tariffs to consumers. Based on his conversations with business leaders, Waller expects the burden of a 10 percent tariff would be shared roughly equally among consumers, importers, and exporters. Under that assumption, the tariffs would temporarily raise inflation by 0.3 percent. If tariffs end up being higher than 10 percent, however, he expects firms will pass more of the cost on to consumers — which he sees as likely, given the limits on how much of the additional cost businesses can absorb. In that case, the effect of tariffs on inflation would be greater.
Waller also addressed concerns that firms might use tariffs as an excuse to opportunistically raise prices — i.e., “greedflation.” He argued that such behavior is unlikely, since firms that raise prices without justification risk losing market share to competitors and alienating loyal customers. In short, Waller does not see greedflation as a significant driver of inflation beyond the direct effects of the tariffs themselves.
The term “transitory” has become something of a dirty word in inflation debates, Waller acknowledged, given the controversy surrounding the Fed’s use of the term during the post-pandemic inflation surge. Nonetheless, he believes that any inflation caused by the tariffs will, in fact, be transitory. He pointed to three factors that contributed to both the severity and persistence of COVID-era inflation — none of which, he argued, are likely to apply in the current context. First, the pandemic led to a significant and prolonged reduction in labor supply, which drove wages — and prices — higher. Second, the associated supply chain disruptions lasted much longer than expected. Third, the scale of fiscal stimulus, combined with the Fed’s accommodative stance, overstimulated aggregate demand.
Waller concluded his remarks with a discussion of diverging inflation expectations. He noted that surveys of household expectations differ significantly from both market-based measures and the projections of professional forecasters. Recent surveys suggest that households anticipate inflation as high as seven percent in the near term. If those expectations were accurate, Waller argued, we would expect to see workers demanding higher wages, along with a rising quits rate as they search for better-paying jobs. We would also expect to see a pickup in household spending as consumers try to make purchases before prices rise further.
As Waller explained, these patterns are not evident in the data. Although wages are rising, they are doing so at a pace consistent with long-run trends. Moreover, the quits rate is now below its pre-pandemic level, and Waller notes that his business contacts have not reported an uptick in wage demands. Similarly, there has been no surge in consumer spending; in fact, it is growing more slowly than in the second half of 2024.
Market-based measures of expected inflation, along with projections by professional forecasters, are much lower than those reported in household surveys. These indicators point to inflation averaging between 2.2 and 2.4 percent over the next few years. Waller explained that financial institutions have strong incentives to forecast inflation accurately, since their profitability depends on incorporating expected inflation into the interest rates they charge. If they were failing to do so, he argued, we would expect to see a surge in loan demand for interest-sensitive goods like homes, automobiles, and other durable goods. But current data from the financial sector shows no such surge. For these reasons, Waller places greater weight on market-based measures and professional forecasts.
The upshot is that, in Governor Waller’s view, inflation expectations remain well anchored — despite the divergence across different measures. Given that, and his expectation that any tariff-induced inflation will be temporary, he believes the Fed should look through the effects of tariffs on the price level when making policy decisions. He concluded by stating that, if tariffs settle closer to his small-tariff scenario and underlying inflation continues converging toward the Fed’s 2 percent goal, he would support cutting the policy rate later this year.