President Trump has said that the Fed should keep interest rates low or even cut them to help the U.S. win the trade war. The Wall Street Journal reports that Eric Rosengren, head of the Boston Fed, thinks that tariffs could instead lead to higher interest rates.
Michael Derby writes:
Long-running tariffs could push up inflation and become a bigger factor for the job market, and the Fed wouldn’t shrug this off, he said. “It’s going to be really hard to distinguish [the tariff impact] particularly in tight labor market,” so the Fed would have to focus on the headline number and proceed accordingly, Mr. Rosengren explained.
Here’s what I gather Rosengren is thinking: Many economists believe that tariffs will push the price level higher. Rosengren appears to think that the Fed should not necessarily tighten money to keep inflation in check when that inflation is caused by tariffs. I assume that’s because he thinks that higher tariffs are a kind of negative supply shock to the economy, and that the right response by a central bank to a negative supply shock is to let them increase prices and decrease economic production, rather than to raise interest rates so as to prevent the inflation but make the hit to production worse.
But he also thinks, I infer, that it will be hard for the Fed to determine the mix of causes for an increase in prices and that it should therefore just try to clamp down on it even at the risk of running too tight a policy.
What Rosengren is running up against is the knowledge problem in monetary policy. It’s a good reason for the Fed to consider switching to a different approach that does not require it to know things it can’t.