US Tariffs and Federal Reserve's Misguided Focus on Inflation

The Federal Reserve spent 2025 focused on the perceived inflationary threat posed by President Trump's tariffs, which led to a cautious monetary policy response. Fed Chairman Jerome Powell indicated that the tariffs were a significant reason for holding back on rate cuts, stating that the Fed was concerned about potential tariff-related price pressures.

However, a new study from the San Francisco Federal Reserve Bank reveals that tariff increases typically correlate with lower inflation and higher unemployment, contradicting the Fed's inflationary perspective.

According to the study, when tariffs rise, they often lead to a decline in demand, which in turn reduces inflation rates. The research highlights that a typical large tariff hike can be associated with approximately two percentage points less inflation and one percentage point higher unemployment.

This misjudgment by the Fed resulted in tighter monetary policy than necessary, further cooling the labor market and freezing the housing market due to elevated interest rates. The Fed's analysis led to two tightening forces in the economy: the disinflationary impact of tariffs and the Fed's cautious stance on rate cuts.

The report emphasizes that the Fed should have recognized tariffs as disinflationary shocks that warranted more aggressive monetary easing rather than restraint. If the Fed had adjusted its views based on this new research, it could have adopted a more supportive stance on economic recovery by cutting rates more decisively.

The overarching question now is whether Federal Reserve officials will adapt their understanding of tariffs in light of this evidence, or if they will maintain their current stance, potentially repeating past errors.

This situation underscores the complexities of monetary policy and the challenges faced by policymakers in balancing trade dynamics with economic stability, ultimately impacting the banking sector and broader financial institutions.