These are perilous times for the Federal Reserve and more inflation

These are perilous times for the Federal Reserve.

President Trump has radically altered U.S. foreign policy and challenged judicial supremacy, but he has been frustrated to meddle with Fed monetary policymaking.

He is lobbying for lower interest rates to cushion the negative effects of his tariffs on growth, but if Chairman Jerome Powell ignores him, Mr. Trump can’t fire him.

Trump’s inflation nation

As a candidate, Mr. Trump was plain about his intention to slash taxes and regulations and impose high tariffs. Wall Street and business leaders wrongly assumed tax and regulatory relief would come quickly and the tariffs would be imposed only after efforts to negotiate better terms of trade with Europe, China and others.

No one seriously considered a wholesale assault on North American supply chains with punitive levies on Mexico and Canada.

Instead, tariff threats have come fast and furious. Deregulation is always a slow process, and tax cuts depend on Congress and are not likely to arrive much before 2026.

The Fed has been challenged to push headline inflation below an annual rate of 2.8% because of persistent cost pressures in the services sector.

Now, Mr. Trump’s tariffs will raise prices. With consumer expectations of rising inflation, those won’t be one-off effects, as Treasury Secretary Scott Bessent argues the Fed should believe. Rather, they will become embedded in workers’ wage demands.

Mr. Trump’s tax cut plans aren’t well-targeted to boost investment and productivity.

Exemptions for tips and Social Security benefits bear little relationship to positive supply-side effects. The 2017 Tax Cuts and Jobs Act lowered the corporate tax rate to 21%, making it more than competitive with other major economies. Taking it to 15% won’t do much more good.

Instead, boosting the federal deficit to well above 7% of gross domestic product will compound the effects of the tariffs and hoist inflation well above an annual rate of 3%.

Getting below 3% again will require the Fed to accept financial markets’ push for the 10-year Treasury and 30-year mortgage rates to rise from 4.2% and 6.7% to more than 5% and 7%.

Abandoning the 2% target

Acceding to Mr. Trump would require the Fed to implicitly abandon its 2% target, and pressure is mounting for that.

All along, Mr. Powell has pursued a soft landing with inflation near the target but without a recession.

At congressional hearings, Sen. John Kennedy, Louisiana Republican, said Mr. Powell should take credit for accomplishing a soft landing. That would imply 2.8% is the new target.

Before COVID-19, inflation averaged 1.5% for more than a decade, and the Fed faced pressure from liberal economists to adopt a higher target. Lately, more moderate commentators have joined that chorus.

Bloomberg columnist John Authers has suggested the current 2.8% is “now within the 3% upper range of the Federal Reserve’s target.” That’s curious because the Fed has never expressed its benchmark regarding a range.

Mohamed A. El-Erian, a respected economist, financial columnist and president of Queens College, Cambridge, has suggested that structural conditions have sufficiently changed since the pre-COVID period to justify a higher target range. He leans heavily on the notion that 2% was a somewhat arbitrary choice without analytical underpinnings.

Sticking to the target

The Fed is charged with accomplishing price stability and maximum employment, and we should at least go back to Chairman Alan Greenspan’s definition. “Price stability is that state in which expected changes in the general price level do not effectively alter business or household decisions.” Otherwise, consumers would constantly try to accelerate purchases of big items such as appliances and cars and inflation would be inclined to continuously accelerate.

With a rate of 2.8% and Mr. Trump threatening tariffs, consumers expect much higher inflation. The respected University of Michigan survey recorded a five-year expectation of 3.9%.

A reckoning for the Fed

The Fed will now have to choose.

The economy was bound to slow even before Mr. Trump made his tariff threats. If he follows through with big levies on Canada, Mexico and Europe, we will likely see growth in the range of 1% or less while inflation accelerates.

At 1% growth, unemployment will rise and the white-collar problem — unemployed middle managers and office workers who face shrinking opportunities owing to artificial intelligence and tougher job searches — will worsen.

If the Fed chooses to reflate the economy, we will be in a world of more than 3% inflation with a constant inclination to accelerate.

If the Fed doesn’t defy Mr. Trump and fails to halt reaccelerating inflation, we could lose our grasp of price stability for a decade or more.

Those of us who remember the 1970s, when the Fed alternated between tapping the brakes and hitting the gas, know that this could lead to ratcheting up inflation to double digits before we are done.

• Peter Morici is an economist, emeritus business professor at the University of Maryland and a national columnist.