Federal Reserve Can Look Through Tariff-Driven Inflation, Fed's Paulson Says
By Matt Grossman
Price increases driven by tariffs will likely prove temporary, according to Philadelphia Fed President Anna Paulson, who also threw her support behind further interest-rate cuts this year as the Fed responds to a slowing labor market.
Goods prices have risen since the Trump administration began implementing steep new tariffs earlier this year, Paulson said Monday in a speech to business economists in Philadelphia. But there is little evidence to suggest that it would spur a sustained cycle of rising prices across the economy, an observation backed up by economic models, she added.
"Here the lessons from economic theory are clear: So long as inflation expectations are anchored, increases in prices due to supply effects do not turn into an inflation problem," Paulson said. Her analysis aligns with that of Fed voters such as governors Christopher Waller and Stephen Miran, who have argued that the Fed should look past tariff effects as well.
In recent months, Chair Jerome Powell has also said that treating tariff-driven price increases as a one-time effect is a "reasonable base case."
Paulson's remarks mark her most detailed public comments on the economy since she took over leadership of the Philly Fed in July.
Given that "momentum in the labor market is to the downside," it makes sense for the Fed to continue cutting interest rates along the lines that the central bank projected last month, she said. In their quarterly dot plot, Fed officials penciled in two more quarter-point rate cuts in 2025, after the central bank lowered its target rate in September for the first time this year.
"Over the rest of this year, I view easing along the lines of the median Summary of Economic Projections policy path as appropriate," Paulson said, using the Fed's formal name for the dot plot that shows officials' forecasts.
Looking ahead, it will probably be appropriate to move interest rates lower, closer to a neutral stance that is no longer leaning against inflation and economic growth, Paulson said. Given uncertainty about what precise interest rate corresponds to neutral, the Fed should move cautiously, she added.
"I think we will need to feel our way there, paying close attention to what economic developments tell us about the stance of policy," she said.
Paulson, formerly a research economist at the Chicago Fed, isn't a voting member of the Fed's policy committee this year, but she will have her first chance at a say in steering interest rates starting in January, when she takes over a rotating policy vote for 2026.
She said the Fed would need to keep a close eye on the interaction between artificial-intelligence hype, the stock market and the broader economy. She added that a surge in enthusiasm for AI has boosted markets, lifted household wealth and helped sustain strong consumer-spending numbers.
If that dynamic fades or reverses, however, a key pillar of recent growth could be demolished at a time when the economy's strength has been concentrated in a circumscribed set of industries and consumers, Paulson said.
"The relatively narrow base of support for the labor market, [and] the importance of high-income consumers together with the prominence of the narrative around AI for equities, adds up to a relatively narrow base of support for growth over the next year or so," Paulson said. "This is something to watch closely."
Write to Matt Grossman at matt.grossman@wsj.com