As Fed Chair Jerome Powell said in his press conference Wednesday, such a scenario would force the central bank to make a “complicated and challenging judgment.”
“We may never face it, but we have to keep it in our thinking now,” Powell said.
When inflation rises, the Fed hikes interest rates to cool the economy. But when unemployment rises, the bank does the opposite and cuts rates to stimulate the economy. In the rare scenario where both inflation and unemployment rise, the Fed tends to have to pick one based on which of the two it believes would be easier to solve, according to Powell.
“We would look at how far they are from the goals, how far they’re expected to be from the goals, what’s the expected time to get back to their goals,” Powell said. “We look at all those things and make a difficult judgment.”
In addition to the increased risks of rising inflation and unemployment, the U.S. also faces the prospect of lower growth. Sluggish growth paired with high rates of inflation leads to stagflation—one of the most feared words in economics.
“If the large increases in tariffs that have been announced are sustained, they’re likely to generate a rise in inflation, a slowdown in economic growth, and an increase in unemployment,” Powell said.
“The Fed isn’t pulling any punches on the potential for tariffs to cause stagflation,” he said.
Of course, what happens next is anyone’s guess.
“If you talk to businesses or market participants or forecasters, everyone is just waiting to see how developments play out,” Powell said, “and then we’ll be able to make a better assessment of what the appropriate path for monetary policy is.”
“It’s going to be an interesting summer,” Greg McBride, chief financial analyst at Bankrate, wrote in a note Wednesday.
“It is tempting to romanticize the idea of lower interest rates, particularly from a borrowing perspective,” McBride said. “But the reason for lower interest rates is very important. We want interest rates to come down because inflation pressures are easing, not because the economy is weakening. Unfortunately, if rates do come down in the coming months, it is more likely because the economy weakened.”
The White House did not immediately respond to a request for comment.
“We would not be making progress toward those goals,” Powell said, “again, if that’s the way the tariffs check out.”
Trade talks with other nations, Powell said, could substantially alter the picture. Treasury Secretary Scott Bessent and U.S. trade representative Jamieson Greer, for example, will meet with Chinese counterparts this week.
The central bank is now at the mercy of the president when it comes to pursuing both full employment and price stability, Robert Conzo, CEO of registered investment advisor the Wealth Alliance, told Fortune.
“The effectiveness of the Fed maintaining their path on this dual mandate,” he wrote in an email, “depends on the ability of the administration to effectively negotiate tariff deals.”
