U.S. economic growth is projected to fall “materially” below its long-term trend, with the unemployment rate expected to rise as businesses and households adapt to price increases driven by new import tariffs. St. Louis Fed President Alberto Musalem expressed concerns over the economic landscape in a recent interview, noting that while he does not foresee a recession, he estimates growth will come in significantly below the approximately 2% trend. Musalem highlighted the risks influencing both growth and inflation, stressing that higher-than-expected tariffs could elevate prices, potentially decreasing household wealth due to equity market fluctuations. This environment raises risks that could slow economic growth further.
The monetary policy response will be contingent on how inflation and unemployment evolve in the following months. Musalem emphasized the importance of anchoring inflation expectations around the Fed’s 2% target to achieve its dual mandate of fostering maximum employment and stable prices. Despite the possibility of a one-time price shock due to tariffs that the Fed might overlook when formulating policy, Musalem cautioned against relying solely on this approach, describing it as “risky.” He raised concerns that expected price increases from the tariffs and international retaliation could lead to more persistent inflation, necessitating a tighter monetary policy.
Conversely, slowing growth could elevate unemployment, which the Fed typically aims to counter with looser monetary conditions. The current sentiment among Fed officials reflects growing anxiety about the broad economic outlook, noting a decline in confidence among households and businesses. Recent volatility in equity markets has led to tightened financial conditions, although Musalem does not perceive current market fluctuations as indicative of dysfunction. He pointed out that while asset prices have experienced significant erratic movements, he hasn’t observed signs of a critical market failure.
Overall, the Fed is navigating a complex economic scenario characterized by slower growth, rising inflation, and uncertainty regarding the future trajectory of monetary policy.