Tariffs Mask Falling Inflation: Business Leaders' Guide To Fed Policy

Core Insights - The research from Harvard Business School's Pricing Lab suggests that inflation may be lower than reported if the effects of tariffs are excluded, indicating potential for the Federal Reserve to lower interest rates further [2][5] - The average pass-through of tariffs to consumers is currently about 20%, which is expected to rise to 100% in the coming years [2] - The Consumer Price Index (CPI) inflation rate would have been approximately 2.2% instead of 2.9% without tariffs, highlighting the significant impact of tariffs on inflation metrics [3][4] Tariff Impact on Inflation - The Federal Reserve's target for inflation, based on the Personal Consumption Expenditures Price Index, translates to about 2.4% CPI inflation, with current estimates suggesting a rate of roughly 2.3% if tariffs were excluded [4] - The Fed has analyzed the implications of tariff-induced price increases and concluded that these should be considered in inflation calculations but excluded from monetary policy decisions [6][8] Monetary Policy Considerations - Tighter monetary policy can reduce non-tariff inflation but cannot prevent price increases due to tariffs, which may lead to a trade-off between inflation control and employment [7] - The Fed is likely to adopt a "see-through" policy approach, focusing on underlying inflation estimates while considering the long-term effects of tariffs on price levels [8][17] Inflation Expectations - The effectiveness of the see-through policy hinges on the public's perception of inflation; if higher inflation is viewed as permanent, tighter monetary policy may be necessary despite potential recession risks [9][16] Gradual Price Adjustments - The impact of tariffs on prices may be gradual, leading to a perception of permanently higher inflation rates, which could influence monetary policy decisions [10][16] - Economic analysis suggests that the pass-through of tariffs into American prices may occur over several years, affecting consumer and business expectations [16]