This morning (April 30), the Bureau of Economic Analysis (BEA) released its advance estimate of GDP for the first quarter of 2025. (The report can be found here.) The BEA estimates that real GDP fell by 0.3 percent, measured at an annual rate, in the first quarter—January through March. Economists surveyed had expected an 0.8 percent increase. Real GDP grew by an estimated 2.5 percent in the fourth quarter of 2024. The following figure shows the estimated rates of GDP growth in each quarter beginning in 2021.
As the following figure—taken from the BEA report—shows, the increase in imports was the most important factor contributing to the decline in real GDP. The quarter ended before the Trump Administration announced large tariff increases on April 2, but the increase in imports is likely attributable to firms attempting to beat the tariff increases they expected were coming.
It’s notable that the change in real private inventories was a large $140 billion, which contributed 2.3 percentage points to the change in real GDP. Again, it’s likely that the large increase in inventories represented firms stockpiling goods in anticipation of the tariff increases.
One way to strip out the effects of imports, inventory investment, and government purchases—which can also be volatile—is to look at real final sales to domestic purchasers, which includes only spending by U.S. households and firms on domestic production. As the following figure shows, real final sales to domestic purchasers increase by 3.0 percent in the first quarter of 2024, which was a slight increase from the 2.9 percent increase in the fourth quarter of 2024. The large difference between the change in real GDP and the change in real final sales to domestic purchasers is an indication of how strongly this quarter’s national income data were affected by businesses anticipating the tariff increases.
In the separate “Personal Income and Outlays” report that the BEA also released this morning, the bureau reported monthly data on the personal consumption expenditures (PCE) price index. The Fed relies on annual changes in the PCE price index to evaluate whether it’s meeting its 2 percent annual inflation target. The following figure shows PCE inflation (the blue line) and core PCE inflation (the red line)—which excludes energy and food prices—for the period since January 2017 with inflation measured as the percentage change in the PCE from the same month in the previous year. In March, PCE inflation was 2.3 percent, down from 2.7 percent in February. Core PCE inflation in March was 2.6 percent, down from 3.0 percent in February. Both headline and core PCE inflation were higher than the forecasts of economists surveyed.
The BEA also released quarterly PCE data as part of its GDP report. The following figure shows quarterly headline PCE inflation (the blue line) and core PCE inflation (the red line). Inflation is calculated as the percentage change from the same quarter in the previous year. Headline PCE inflation in the first quarter was 2.5 percent, unchanged from the fourth quarter of 2025. Core PCE inflation was 2.8 percent, also unchanged from the fourth quarter of 2025. Both measures were still above the Fed’s 2 percent inflation target.
The following figure shows quarterly PCE inflation and quarterly core PCE inflation calculated by compounding the current quarter’s rate over an entire year. Measured this way, headline PCE inflation increased from 2.4 percent in the fourth quarter of 2024 to 3.6 percent in the first quarter of 2025. Core PCE inflation increased from 2.6 percent in the fourth quarter of 2024 to 3.5 percent in the first quarter of 2025. Clearly, the quarterly data show significantly higher inflation than do the monthly data. As we discuss in this blog post, tariff increases result in an aggregate supply shock to the economy. As a result, unless the current and scheduled tariff increases are reversed, we will likely see a significant increase in inflation in the coming months. So, neither the monthly nor the quarterly PCE data may be giving a good indication of the course of future inflation.
What should we make of today’s macro data releases? First, it’s important to remember that these data will be subject to revisions in coming months. If we are heading into a recession, the revisions may well be very large. Second, we are sailing into unknown waters because the U.S. economy hasn’t experienced tariff increases as large as these since passage of the Smoot-Hawley Tariff in 1930. Third, at this point we don’t know whether some, most, all, or none of the tariff increases will be reversed as a result of negotiations during the coming weeks. Finally, on Friday, the Bureau of Labor Statistics will release its “Employment Situation Report” for March. That report will provide some additional insight into the state of the economy—as least as it was in March before the full effects of the tariffs have been felt.
An image generated by ChatGTP-4o of a hypothetical meeting between President Richard Nixon and Fed Chair Arthur Burns in the White House.
In a speech on April 15 at the Economic Club of Chicago, Federal Reserve Chair Jerome Powell discussed how the Fed might react to President Donald Trump’s tariff increases: “Tariffs are highly likely to generate at least a temporary rise in inflation. The inflationary effects could also be more persistent…. Our obligation is to keep longer-term inflation expectations well anchored and to make certain that a one-time increase in the price level does not become an ongoing inflation problem.”
Powell’s remarks were interpreted as indicating that the Fed’s policymaking Federal Open Market Committee (FOMC) was unlikely to cut its target for the federal funds rate anytime soon. President Trump, who has stated several times that the FOMC should cut its target, was displeased with Powell’s position and posted on social media that “Powell’s termination cannot come fast enough!” Stock prices declined sharply on the possibility that Trump might try to fire Powell because many economists and market participants believed that move would increase uncertainty and possibly undermine the FOMC’s continuing attempts to bring inflation down to the Fed’s 2 percent target. Trump, possibly responding to the fall in stock prices, stated to reporters that he had “no intention” of firing Powell. In this recent blog post we discuss the debate over whether presidents can legally fire Fed chairs.
Leaving aside the legal issue of whether a president can fire a Fed chair, would it be better or worse for the conduct of monetary if the presdient did have that power? We review the arguments for and against the Fed conducting monetary policy independently of the president and Congress in Macroeconomics, Chapter 17, Section 17.4 (Economics, Chapter 27, Section 27.4). One key point that’s often made in favor of Fed independence is illustrated in Figure 17.12, which is reproduced below.
The figure is from a classic study by Alberto Alesina and Lawrence Summers, who were both economists at Harvard University at the time. Alesina and Summers tested the assertion that the less independent a country’s central bank, the higher the country’s inflation rate will be by comparing the degree of central bank independence and the inflation rate for 16 high-income countries during the years from 1955 to 1988. As the figure shows, countries with highly independent central banks, such as the United States, Switzerland, and Germany, had lower inflation rates than countries whose central banks had little independence, such as New Zealand, Italy, and Spain. In the following years, New Zealand and Canada granted their banks more independence, at least partly to better fight inflation.
Debates over Fed independence didn’t start with President Trump and Fed Chair Powell; they date all the way back to the passage of the Federal Reserve Act in 1913. The background to the passage of the Act is the political struggle over establishing a central bank during the early years of the country. In 1791, Congress established the Bank of the United States, at the urging of the country’s first Treasury secretary, Alexander Hamilton. When the bank’s initial 20-year charter expired in 1811, political opposition kept the charter from being renewed, and the bank went out of existence. The bank’s opponents believed that the bank’s actions had the effect of reducing loans to farmers and owners of small businesses and that Congress had exceeded its constitutional authority in establishing the bank. Financial problems during the War of 1812 led Congress to charter the Second Bank of the United States in 1816. But, again, political opposition, this time led by President Andrew Jackson, resulted in the bank’s charter not being renewed in 1836.
As we discuss in Chapter 14, Section 14.4, Congress established the Federal Reserve as a lender of last resort to bring an end to bank panics. In 1913, Congress was less concerned aboout making the Fed independent from Congress and the president than it was in overcoming political opposition to establishing a central bank located in Washington, DC. Accordingly, Congress established a decentralized system by having 12 District Banks that would be owned by the member banks in the district. Congress gave the responsibility for overseeing the system to the Federal Reserve Board, which was the forerunner of the current Board of Governors. The president had a greater influence on the Federal Reserve Board than presidents today have on the Board of Governors because the Federal Reserve Board included the secretary of the Treasury and the comptroller of the currency as members. Then as now, the president is free to replace the secretary of the Treasury and the comptroller of the currency at any time.
When the United States entered World War I in April 1917, the Fed came under pressure to help the Treasury finance the war by making loans to banks to help the banks purchase Treasury securities—Liberty Bonds—and by lending funds to banks that banks could loan to households to purchase bonds. In 1919, a ruling by the attorney general clarified that Congress had intended in the Federal Reserve Act to give the Federal Reserve Board the power to set the discounts rate the 12 District Banks charged member banks on loans.
Despite this ruling, authority within the Fed remained much more divided than is true today. Divided authority proved to be a serious problem when the Fed had to deal with the Great Depression, which began in August 1929 and worsened as the result of a series of bank panics. As we’ve seen, the secretary of the Treasury and the comptroller of the currency, both of whom report directly to the president of the United States, served on the Federal Reserve Board. So, the Fed had less independence from the executive branch of the government than it does today.
In addition, the heads of the 12 District Banks operated much more independently than they do today, with the head of the Federal Reserve Bank of New York having nearly as much influence within the system as the head of the Federal Reserve Board. At the time of the bank panics, George Harrison, the head of the Federal Reserve Bank of New York, served as chair of the Open Market Policy Conference, the predecessor of the current Federal Open Market Committee. Harrison frequently acted independently of Roy Young and Eugene Meyer, who served as heads of the Federal Reserve Board during those years. Important decisions could be made only with the consensus of these different groups. During the early 1930s, consensus proved hard to come by, and taking decisive policy actions was difficult.
The difficulties the Fed had in responding to the Great Depression led Congress to reorganize the system with the passage of the Banking Act of 1935. Most of the current structure of the Fed was put in place by that law. Power was concentrated in the hands of the Board of Governors. The removal of the secretary of the Treasury and the comptroller of the currency from the Board reduced the ability of the president to influence the Fed’s decisions.
During World War II, the Fed again came under pressure to help the federal government finance the war. The Fed agreed to hold interest rates on Treasury securities at low levels: 0.375% on Treasury bills and 2.5% on Treasury bonds. The Fed could keep interest rates at these low levels only by buying any bonds that were not purchased by private investors, thereby fixing, or pegging, the rates.
When the war ended in 1945, the Treasury and President Harry Truman wanted to continue this policy, but the Fed didn’t agree. The Fed’s concern was inflation: Larger purchases of Treasury securities by the Fed could increase the growth rate of the money supply and the rate of inflation. Fed Chair Marriner Eccles strongly objected to the policy of fixing interest rates. His opposition led President Truman to not reappoint him as chair in 1948,although Eccles continued to fight for Fed independence during the remainder of his time as a governor. On March 4, 1951, the federal government formally abandoned the wartime policy of fixing the interest rates on Treasury securities with the Treasury–Federal Reserve Accord. This agreement was important in eestablishing the Fed’s ability to operate independently of the Treasury.
Conflicts between the Treasury and the Fed didn’t end with that agreement, however. Thomas Drechsel of the University of Maryland has analyzed the daily schedules of presidents during the period from 1933 to 2016 and finds that during these years presidents met with Fed officials on more than 800 occasions. Of course, not all of these interactions involved attempts by a president to influence the actions of a Fed Chair, but some seem to have. For example, research by Helen Fessenden of the Federal Reserve Bank of Richmond has shown that in 1967, President Lyndon Johnson, who was facing reelection in 1968, was anxious that Fed Chair William McChesney Martin adopt a more expansionary monetary policy. There is some evidence that Johnson and Martin came to an agreement that if Johnson agreed to push Congress to increase taxes, Martin would pursue an expansionary monetary policy.
An image generated by ChatGTP-4o of a hypothetical meeting between President Lyndon Johnson and Fed Chair William McChesney Martin in the White House.
Similarly, in late 1971, President Richard Nixon was concerned that the unemployment rate was at 6%, which he believed would, if it persisted, endanger his chance of reelection in 1972. Dreschel finds that Nixon met with Fed Chair Arthur Burns 34 times during the second half of 1971. Evidence from tape recordings of Nixon’s conversations with Burns at the White House and from Burns’s diary entries indicate that Nixon pressured Burns to increase the rate of growth of the money supply and that Burns agreed to do so.
President Ronald Reagan and Federal Reserve Chair Paul Volcker argued over who was at fault for the severe economic recession of the early 1980s. Reagan blamed the Fed for soaring interest rates. Volcker held that the Fed could not take action to bring down interest rates until the budget deficit—which results from policy actions of the president and Congress—was reduced. Similar conflicts occurred during the administrations of George H.W. Bush and Bill Clinton, with the Treasury frequently pushing for lower short-term interest rates than the Fed considered advisable.
During the financial crisis of 2007–2009 and during the 2020 Covid pandemic, the Fed worked closely with the Treasury. The relationship was so close, in fact, that some economists and policymakers worried that the Fed might be sacrificing some of its independence. The frequent consultations between Fed Chair Ben Bernanke and Treasury Secretary Henry Paulson in the fall of 2008, during the height of the crisis, were a break with the tradition of Fed chairs formulating policy independently of a presidential administration. During the 2020 pandemic, Fed Chair Jerome Powell and Treasury Secretary Steven Mnuchin also frequently consulted on policy.
These examples from the Fed’s history indicate that presidents have persistently attempted to influence Fed policy. Most economists believe that central bank independence is an important check on inflation. But, given the importance of monetary policy, it’s probably inevitable that presidents and members of Congress will continue to attempt to sway Fed policy.
Supports:Money, Banking, and the Financial System, Chapter 3, Section 3.5
Image generated by ChatGTP-4o
The 30-year U.S. Treasury bond has the longest maturity available on a bond issued by the U.S. government. Some other governments have issued century bonds, which are bonds that don’t mature for 100 years. Bonds with maturities longer than 30 years are sometimes called ultra-long-term bonds. For example, in June 2020 the government of Austria issued a bond that will mature in June 2120. The bond has a par value of €100 and a coupon rate of 0.85%, which seems low but was high in comparison with the yields on other European government bonds at the time. For example, the yield on the 10-year German government bond was negative from April 2019 through January 2021.
Today (April 25), in a newsletter from the Wall Street Journal, Spencer Jakab noted that: “With a little over 95 years remaining, those [Austrian century] bonds now fetch 35 cents on the euro. Investors aren’t worried about being repaid ….”
a. What does Jakab mean that the “bonds now fetch 35 cents on the euro”?
b. If the investors aren’t worried about the Austrian government making coupon or principal payments on the bond, why do the bonds fetch only 35 cents on the euro?
Solving the Problem Step 1: Review the chapter material. This problem is about the relationship between the interest-rate risk on a bond and the bond’s maturity, so you may want to review Money, Banking, and the Financial System, Chapter 3, Section 3.5, “Interest Rates and Rates of Return.”
Step 2: Answer part a. by explaining what Jakab means by writing that Austrian century bonds that mature in 2120 now fetch “35 cents on the euro.” The bonds have a par value (or face value) of €100. By “35 cents on the euro,” Jakab must mean that the current price the bonds are trading at is €35.
Step 3: Answer part b. by explaining why the market price of these Austrian century bonds has declined by 65% from their par value even though the bonds have low default risk. As we discuss in this section of the textbook, long-term bonds have substantial interest-rate risk—the risk that the price of the bond will fluctuate in response to changes in market interest rates—even if they have very low default risk—the risk that an investor won’t receive the coupon and principal payments on the bond. As Table 3.2 in this section shows, the longer the maturity of a bond, the greater the interest-rate risk. As market interest rates on other government bonds have risen, the yield on the Austrian century bonds has also had to rise for investors to be willing to buy these bonds. With a fixed coupon rate of 0.85%, the only way for the yield to rise is for the price of the bonds to fall. Given the very long maturity of these bonds, the price has had to fall by 65% from its par value to make the yield on the bonds competitive with other government bonds.
Recently, Glenn appeared on the Firing Line program to discuss tariffs. Coincidentally, Margaret Hoover, the host of the program, is the great-granddaughter of Herbert Hoover. Herbert Hoover was the president who signed the Smoot-Hawley Tariff bill in 1930. We discussed the Smoot-Hawley Tariff in a recent blog post.
Image generated by ChatGTP-4o One of the key issues in monetary policy—dating back decades—is whether policy should be governed by a rule or whether the members of the Federal Open Market Committee (FOMC) should make “data-driven” decisions. Currently, the FOMC believes that the best approach is to let macroeconomic data drive decisions about the appropriate target … Continue reading “Should We Turn Monetary Policy over to Generative Artificial Intelligence?”
Image generated by ChatGTP-4o
One of the key issues in monetary policy—dating back decades—is whether policy should be governed by a rule or whether the members of the Federal Open Market Committee (FOMC) should make “data-driven” decisions. Currently, the FOMC believes that the best approach is to let macroeconomic data drive decisions about the appropriate target for the federal funds rate rather than to allow a policy rule to determine the target.
In its most recent Monetary Policy Report to Congress, the Fed’s Board of Governors noted that policy rules “can provide useful benchmarks for the consideration of monetary policy. However, simple rules cannot capture all of the complex considerations that go into the formation of appropriate monetary policy, and many practical considerations make it undesirable for the FOMC to adhere strictly to the prescriptions of any specific rule.” We discuss the debate over monetary policy rules—sometimes described as the debate over “rules versus discretion” in conducting policy—in Macroeconomics, Chapter 15, Section 15.5 (Economics, Chapter 25, Section 25.5.)
Probably the best known advocate of the Fed relying on policy rules is John Taylor of Stanford University. The Taylor rule for monetary policy begins with an estimate of the value of the real federal funds rate, which is the federal funds rate—adjusted for inflation—that would be consistent with real GDP being equal to potential real GDP in the long run. With real GDP equal to potential real GDP, cyclical unemployment should be zero, and the Fed will have attained its policy goal of maximum employment, as the Fed defines it.
According to the Taylor rule, the Fed should set its current federal funds rate target equal to the sum of the current inflation rate, the equilibrium real federal funds rate, and two additional terms. The first of these terms is the inflation gap—the difference between current inflation and the target rate (currently 2 percent, as measured by the percentage change in the personal consumption expenditures (PCE) price index; the second term is the output gap—the percentage difference of real GDP from potential real GDP. The inflation gap and the output gap are each given “weights” that reflect their influence on the federal funds rate target. With weights of one-half for both gaps, we have the following Taylor rule:
Federal funds rate target = Current inflation rate + Equilibrium real federal funds rate + (1/2 × Inflation gap) + (1/2 × Output gap).
So when the inflation rate is above the Fed’s target rate, the FOMC will raise the target for the federal funds rate. Similarly, when the output gap is negative—that is, when real GDP is less than potential GDP—the FOMC will lower the target for the federal funds rate. In calibrating this rule, Taylor assumed that the equilibrium real federal funds rate is 2 percent and the target rate of inflation is 2 percent. (Note that the Taylor rule we are using here was the one Taylor first proposed in 1993. Since that time, Taylor and other economists have also analyzed other similar rules with, for instance, an assumption of a lower equilibrium real federal funds rate.)
The following figure shows the level of the federal funds rate that would have occurred if the Fed had strictly followed the original Taylor rule (the blue line) and the actual federal funds rate (the red line). The figure indicates that because during many years the two lines are close together, the Taylor rule does a reasonable job of explaining Federal Reserve policy. There are noticeable exceptions, however, such as the period of high inflation that began in the spring of 2021. During that period, the Taylor rule indicates that the FOMC should have begun raising its target for the federal funds rate earlier and raised it much higher than it did.
Taylor has presented a number of arguments in favor of the Fed relying on a rule in conducting monetary policy, including the following:
A simple policy rule (such as the Taylor rule) makes it easier for households, firms, and investors to understand Fed policy.
Conducting policy according to a rule makes it less likely that households, firms, and investors will be surprised by Fed policy.
Fed policy is less likely to be subject to political pressure if it follows a rule: “If monetary policy appears to be run in an ad hoc and complicated way rather than a systematic way, then politicians may argue that they can be just as ad hoc and interfere with monetary policy decisions.”
Following a rule makes it easier to hold the Fed accountable for policy errors.
The Fed hasn’t been persuaded by Taylor’s arguments, preferring its current data-driven approach. In setting monetary policy, the members of the FOMC believe in the importance of being forward looking, attempting to take into account the future paths of inflation and unemployment. But committee members can struggle to accurately forecast inflation and unemployment. For instance, at the time of the June 2021 meeting of the FOMC, inflation had already risen above 4%. Nevertheless, committee members forecast that inflation in 2022 would be 2.1%. Inflation in 2022 turned out to be much higher—6.6%.
To succeed with a data-driven approach to policy, members of the FOMC must be able to correctly interpret the importance of new data on economic variables as it becomes available and also accurately forecast the effects of policy changes on key variables, particularly unemployment and inflation. How do the committee members approach these tasks? To some extent they rely on formal economic models, such as those developed by the economists on the committee’s staff. But, judging by their speeches and media interviews, committee members also rely on qualitative analysis in interpreting new data and in forming their expectations of how monetary policy will affect the economy.
In recent years, generative artificial intelligence (AI) and machine learning (ML) programs have made great strides in analyzing large data sets. Should the Fed rely more heavily on these programs in conducting monetary policy? The Fed is currently only in the beginning stages of incorporating AI into its operations. In 2024, the Fed appointed a Chief Artificial Intelligence Officer (CAIO) to coordinate its AI initiatives. Initially, the Fed has used AI primarily in the areas of supervising the payment system and promoting financial stability. AI has the ability to quickly analyze millions of financial transactions to identify those that may be fraudulent or may not be in compliance with financial and banking regulations. How households, firms, and investors respond to Fed policies is an important part of how effective the policies will be. The Fed staff has used AI to analyze how financial markets are likely to react to FOMC policy announcements.
The Central Bank of Canada has gone further than the Fed in using AI. According to Tiff Macklem, the Governor of the Bank of Canada, AI is used to:
• forecast inflation, economic activity and demand for bank notes • track sentiment in key sectors of the economy • clean and verify regulatory data • improve efficiency and de-risk operations
Will central banks begin to use AI to carry out the key activity of setting policy interest rates, such as the federal funds rate in the United States? AI has the potential to adjust the federal funds rate more promptly than the members of the FOMC are able to do in their eight yearly meetings. Will it happen? At this point, generative AI and ML models are not capable of taking on that responsibility. In addition, as noted earlier, Taylor and other supporters of rules-based policies have argued that simple rules are necessary for the public to understand Fed policy. AI generated rules are likely to be too complex to be readily understood by non-specialists.
It’s too early in the process of central banks adopting AI in their operations to know the eventual outcome. But AI is likely to have a significant effect on central banks, just as it is already affecting many businesses.
In this photo of a Federal Open Market Committee meeting, Fed Chair Jerome Powell is on the far left and Fed Governor Christopher Waller is the third person to Powell’s left. (Photo from federalreserve.gov)
This post discusses two developments this week that involve the Federal Reserve. First, we discuss the apparent disagreement between Fed Chair Jerome Powell and Fed Governor Christopher Waller over the best way to respond to the Trump Administration’s tariff increases. As we discuss in this blog post and in this podcast, in terms of the aggregate demand and aggregate supply model, a large unexpected increase in tariffs results in an aggregate supply shock to the economy, shifting the short-run aggregate supply curve (SRAS) to the left. The following is Figure 13.7 from Macroeconomics (Figure 23.7 from Economics) and illustrates the effects of an aggregate supply shock on short-run macroeconomic equilibrium.
Although the figure shows the effects of an aggregate supply shock that results from an unexpected increase in oil prices, using this model, the result is the same for an aggregate supply shock caused by an unexpected increase in tariffs. Two-thirds of U.S. imports are raw materials, intermediate goods, or capital goods, all of which are used as inputs by U.S. firms. So, in both the case of an increase in oil prices and in the case of an increase in tariffs, the result of the supply shock is an increase in U.S. firms’ production costs. This increase in costs reduces the quantity of goods firms will supply at every price level, shifting the SRAS curve to the left, as shown in panel (a) of the figure. In the new macroeconomic equilibrium, point B in panel (a), the price level increases and the level of real GDP declines. The decline in real GDP will likely result in an increase in the unemployment rate.
An aggregate supply shock poses a policy dilemma for the Fed’s policymaking Federal Open Market Committee (FOMC). If the FOMC responds to the decline n real GDP and the increase in the unemployment rate with an expansionary monetary policy of lowering the target for the federal funds rate, the result is likely to be a further increase in the price level. Using a contractionary monetary policy of increasing the target for the federla funds rate to deal with the rising price level can cause real GDP to fall further, possibly pushing the economy into a recession. One way to avoid the policy dilemma from an aggregate supply shock caused by an increase in tariffs is for the FOMC to “look through”—that is, not respond—to the increase in tariffs. As panel (b) in the figure shows, if the FOMC looks through the tariff increase, the effect of the aggregate supply shock can be transitory as the economy absorbs the one-time increase in the price level. In time, real GDP will return to equilibrium at potential real GDP and the unemployment rate will fall back to the natural rate of unemployment.
On Monday (April 14), Fed Governor Christopher Waller in a speech to the Certified Financial Analysts Society of St. Louis made the argument for either looking through the macroeconomic effects of the tariff increase—even if the tariff increase turns out to be large, which at this time is unclear—or responding to the negative effects of the tariffs increases on real GDP and unemployment:
“I am saying that I expect that elevated inflation would be temporary, and ‘temporary’ is another word for ‘transitory.’ Despite the fact that the last surge of inflation beginning in 2021 lasted longer than I and other policymakers initially expected, my best judgment is that higher inflation from tariffs will be temporary…. While I expect the inflationary effects of higher tariffs to be temporary, their effects on output and employment could be longer-lasting and an important factor in determining the appropriate stance of monetary policy. If the slowdown is significant and even threatens a recession, then I would expect to favor cutting the FOMC’s policy rate sooner, and to a greater extent than I had previously thought.”
In a press conference after the last FOMC meeting on March 19, Fed Chair Jerome Powell took a similar position, arguing that: “If there’s an inflation that’s going to go away on its own, it’s not the correct response to tighten policy.” But in a speech yesterday (April 16) at the Economic Club of Chicago, Powell indicated that looking through the increase in the price level resulting from a tariff increase might be a mistake:
“The level of the tariff increases announced so far is significantly larger than anticipated. The same is likely to be true of the economic effects, which will include higher inflation and slower growth. Both survey- and market-based measures of near-term inflation expectations have moved up significantly, with survey participants pointing to tariffs…. Tariffs are highly likely to generate at least a temporary rise in inflation. The inflationary effects could also be more persistent…. Our obligation is to keep longer-term inflation expectations well anchored and to make certain that a one-time increase in the price level does not become an ongoing inflation problem.”
In a discussion following his speech, Powell argued that tariff increases may disrupt global supply chains for some U.S. industries, such as automobiles, in way that could be similar to the disruptions caused by the Covid pandemic of 2020. As a result: “When you think about supply disruptions, that is the kind of thing that can take time to resolve and it can lead what would’ve been a one-time inflation shock to be extended, perhaps more persistent.” Whereas Waller seemed to indicate that as a result of the tariff increases the FOMC might be led to cut its target for the federal funds sooner or to larger extent in order to meet the maximum employment part of its dual mandate, Powell seemed to indicate that the FOMC might keep its target unchanged longer in order to meet the price stability part of the dual mandate.
Powell’s speech caught the notice of President Donald Trump who has been pushing the FOMC to cut its target for the federal funds rate sooner. An article in the Wall Street Journal, quoted Trump as posting to social media that: “Powell’s termination cannot come fast enough!” Powell’s term as Fed chair is scheduled to end in May 2026. Does Trump have the legal authority to replace Powell earlier than that? As we discuss in Macroeconomics, Chapter 27 (Economics Chapter 17), according to the Federal Reserve Act, once a Fed chair is notimated to a four-year term by the president (President Trump first nominated Powell to be chair in 2017 and Powell took office in 2018) and confirmed by the Senate, the president cannot remove the Fed chair except “for cause.” Most legal scholars argue that a president cannot remove a Fed chair due to a disagreement over monetary policy.
Article I, Section II of the Constitution of the United States states that: “The executive Power shall be vested in a President of the United States of America.” The ability of Congress to limit the president’s power to appoint and remove heads of commissions, agencies, and other bodies in the executive branch of government—such as the Federal Reserve—is not clearly specified in the Constitution. In 1935, a unanimous Supreme Court ruled in the case of Humphrey’s Executor v. United States that President Franklin Roosevelt couldn’t remove a member of the Federal Trade Commission (FTC) because in creating the FTC, Congress specified that members could only be removed for cause. Legal scholars have presumed that the ruling in this case would also bar attempts by a president to remove members of the Fed’s Board of Governors because of a disagreement over monetary policy.
The Trump Administration recently fired a member of the National Labor Relations Board and a member of the Merit Systems Protection Board. The members sued and the Supreme Court is considering the case. The Trump Adminstration is asking the Court to overturn the Humphrey’s Executor decision as having been wrongly decided because the decision infringed on the executive power given to the president by the Constitution. If the Court agrees with the administration and overturns the precdent established by Humphrey’s Executor, would President Trump be free to fire Chair Powell before Powell’s term ends? (An overview of the issues involved in this Court case can be found in this article from the Associated Press.)
The answer isn’t clear because, as we’ve noted in Macroeconomics, Chapter 14, Section 14.4, Congress gave the Fed an unusual hybrid public-private structure and the ability to fund its own operations without needing appropriations from Congress. It’s possible that the Court would rule that in overturning Humphrey’s Executor—if the Court should decide to do that—it wasn’t authorizing the president to replace the Fed chair at will. In response to a question following his speech yesterday, Powell seemed to indicate that the Fed’s unique structure might shield it from the effects of the Court’s decision.
If the Court were to overturn its ruling in Humphrey’s Executor and indicate that the ruling did authorize the president to remove the Fed chair, the Fed’s ability to conduce monetary policy independently of the president would be seriously undermined. In Macroeconomics, Chapter 17, Section 17.4 we review the arguments for and against Fed independence. It’s unclear at this point when the Court might rule on the case.
Supports:Microeconomics and Economics, Chapter 6, and Essentials of Economics, Chapter 7, Section 7.5-7.7
ChatGTP-4o image of cars in the Lincoln Tunnel, which connects New Jersey with midtown Manhattan.
In January 2025, New York City began enforcing congestion pricing in the borough of Manhattan south of 60th Street—the congestion relief zone. The Metropolitan Transportation Authority (MTA) in New York collects a toll from a vehicle entering that zone either automatically using the vehicle’s E-ZPass transponder or by reading the vehicle’s license plate and mailing a bill to the vehicle’s owner. Nobel Laureate William Vickrey of Columbia University first proposed congestion pricing in the 1950s as a way to deal with the negative externalities from traffic congestion. Congestion pricing acts as a Pigovian tax that internalizes the external costs drivers generate by using streets in congested areas. (We discuss Pigovian taxes in Microeconomics and Economics, Chapter 5, Section 5.3, and in Essentials of Economics, Chapter 4, Section 4.3.)
The New York City congestion toll is somewhat complex, varying according to the type of vehicle and how the vehicle enters the area in which the toll applies. The congestion toll fora car entering Manhattan through the Lincoln Tunnel on a weekday between 5 am and 9 pm is $6.00 on top of the existing toll of $16.06. In January 2025, the volume of cars driving through the Lincoln Tunnel declined by 8 percent during the weekday hours of 5 am to 9 pm. According to an article in Crain’s New York Business, the number of vehicles entering the congestion relief zone compared with the same month in the previous year declined by 8 percent in January, 12 percent in February, and 13 percent in March.
From the information given, can we determine the price elasticity of demand for entering Manhattan by driving though the Lincoln Tunnel during weekdays from 5am to 9am? Briefly explain.
Suppose someone makes the following claim: “Because the quantity of cars using the Lincoln Tunnel has declined by 8 percent, we know that the MTA must have collected less revenue from cars using the tunnel than before the congestion toll was imposed.” Briefly explain whether you agree.
Is the pattern of increasing percentage declines in vehicle traffic in the congestion relief zone each month from January to March what we would expect? Be sure your answer refers to concepts related to the price elasticity of demand.
Step 1: Review the chapter material. This problem is about the price elasticity of demand, so you may want to review Chapter 6, Sections 6.1-6.4.
Step 2: Answer part (a) by explaining whether from the information given we can determine the price elasticity of demand for entering Manhattan by driving through the Lincoln Tunnel. We do have sufficient information to determine the price elasticity, provided that nothing else that would affect the demand for driving through the Lincoln Tunnel changed during January. We’re told the percentage change in the quantity demand, so we need only to calculate the percentage change in the price to determine the price elasticity. The change in the price is the $6 congestion toll. The average of the price before and the price after the toll is imposed is ($16.06 + $22.06) = $19.06. Therefore, the percentage change in the price is ($6/$19.06) × 100 = 31.5 percent. The price elasticity of demand is equal to the percentage change in quantity dmanded divided by the percentage change in price: –6%/31.5% = –0.3. Because this value is less than 1 in absolute value, we can conclude that the demand for driving through the Lincoln Tunnel is price inelastic.
Step 3: Answer part (b) by explaining whether because the quantity of cars driving through the Lincoln Tunnel has declined the MTA must have collected less revenue from cars using the tunnel. As shown in Section 6.3 of the textbook, total revenue received will fall after a price increase only if demand is price elastic. In this case, demand is price inelastic, so the total revenue the MTA collects from cars using the Lincoln Tunnel will rise, not fall.
Step 3: Answer part (c) by explaining whether the pattern of increasing percentage declines in vehicle traffic in the congestion relief zone is one we would expect. In Section 6.2, we see that the passage of time is one of the determinants of the price elasticity of demand. The more time that passes, the more price elastic the demand for a product becomes. In other words, the longer the time that people have to adjust to the congestion toll—by, for instance, taking a bus rather than driving through the Lincoln Tunnel in a car—the more likely it is that people will decide not to drive into the congestion relief zone. So, it is not surprising that the number of vehicles entering the congestion relief zone declined by a greater percentage each month from January to March.
Photo of U.S. President Donald Trump and China President Xi Jinping from Reuters.
The tit-for-tat tariff increases the U.S. and Chinese governments have levied on each other’s imports have reached dizzying heights today (April 11). The United States has imposed a tariff rate of 134.7 percent on imports from China, while China has imposed a tariff rate of 147.6 percent on imports from the United States. On all other countries—the rest of the world (ROW)—the United States imposes an average tariff rate of 10.5 percent, which is a sharp increase reflecting the Trump Administration’s imposition of a tariff of at least 10 percent on all countries. The government of China imposes a tariff rate of 6.5 percent on the ROW.
The Peterson Institute for International Economics (PIIE) is a think tank located in Washington, DC. Chad Brown, a senior fellow at PIIE, has created two charts that dramatically illustrate the current state of the U.S.-China trade war. The first chart shows the changes since the beginning of the first Trump Administration in 2017 in the tariff rates the countries have imposed on each other’s imports.
The second chart shows the percentage of each country’s exports to the other country that have been subject to tariffs. As of today, 100 percent of each country’s exports are subject to the other country’s tariffs.
Finally, we repeat a figure from an earlier blog post showing changes over time in the average tariff rate the United States levies on imports. The value for 2025 of 16.5 percent is an estimate by the Tax Foundation and assumes that the tariff rates that the Trump Administration announced on April 2 go into force, although the rates are currently suspended for 90 days—apart from those imposed on China. (An average tariff rate of 16.5 percent would be the highest levied by the United States since 1937.)
Thanks to Fernando Quijano for preparing this figure.
Today (April 10), the Bureau of Labor Statistics (BLS) released its monthly report on the consumer price index (CPI). The following figure compares headline inflation (the blue line) and core inflation (the red line).
The headline inflation rate, which is measured by the percentage change in the CPI from the same month in the previous year, was 2.4 percent in March—down from 2.8 percent in February.
The core inflation rate,which excludes the prices of food and energy, was 2.8 percent in March—down from 3.1 percent in February.
Both headline inflation and core inflation were below what economists surveyed had expected.
In the following figure, we look at the 1-month inflation rate for headline and core inflation—that is the annual inflation rate calculated by compounding the current month’s rate over an entire year. Calculated as the 1-month inflation rate, headline inflation (the blue line) fell sharply from 2.6 percent in March to –0.6 percent—that is, the economy experienced deflation in March. Core inflation (the red line) decreased from 2.6 percent in February to 0.7 percent in March.
Overall, considering 1-month and 12-month inflation together, inflation slowed significantly in March. Of course, it’s important not to overinterpret the data from a single month. The figure shows that 1-month inflation rate is particularly volatile. Also note that the Fed uses the personal consumption expenditures (PCE) price index, rather than the CPI, to evaluate whether it is hitting its 2 percent annual inflation target.
There’s been considerable discussion in the media about continuing inflation in grocery prices. In the following figure the blue line shows inflation in the CPI category “food at home,” which is primarily grocery prices. Inflation in grocery prices was 2.4 percent in March, up from 1.8 percent in February, but still far below the peak of 13.6 percen in August 2022. Although, on average, grocery price inflation has been low over the past 18 months, there have been substantial increases in the prices of some food items. For instance, egg prices—shown by the red line—increased by 108.1 percent in March. But, as the figure shows, egg prices are usually quite volatile month-to-month, even when the country is not dealing with an epidemic of bird flu.
To better estimate the underlying trend in inflation, some economists look at median inflation and trimmed mean inflation.
Median inflation is calculated by economists at the Federal Reserve Bank of Cleveland and Ohio State University. If we listed the inflation rate in each individual good or service in the CPI, median inflation is the inflation rate of the good or service that is in the middle of the list—that is, the inflation rate in the price of the good or service that has an equal number of higher and lower inflation rates.
Trimmed-mean inflation drops the 8 percent of goods and services with the highest inflation rates and the 8 percent of goods and services with the lowest inflation rates.
The following figure shows that 12-month trimmed-mean inflation (the blue line) was 3.0 percent in March, down from 3.1 percent in February. Twelve-month median inflation (the red line) also declined slightly from 3.1 percent in February to 3.0 percent in March.
The following figure shows 1-month trimmed-mean and median inflation. One-month trimmed-mean inflation fell from 3.3 percent in February to 2.6. percent in March. One-month median inflation increased from 3.5 percent in February to 4.1 percent in March. These data are noticeably higher than either the 12-month measures for these variables or the 1-month and 12-month measures of headline and core inflation. Again, though, all 1-month inflation measures can be volatile.
There isn’t much sign in today’s CPI report that the tariffs recently imposed by the Trump Administration have affected retail prices. President Trump announced yesterday that many of the tariffs would be suspended for at least 90 days, although the across-the-board tariff of 10 percent remains in place and a tariff of 145 percent has been imposed on goods imported from China. It would surprising if those tariff increases don’t begin to have at least some effect on the CPI over the next few months. As we noted in this post from earlier in the month, Tariffs pose a dilemma for the Fed, because tariffs have the effect of both increasing the price level and reducing real GDP and employment.
What are the implications of this CPI report for the actions the Federal Reserve’s policymaking Federal Open Market Committee (FOMC) may take at its next two meetings? Investors who buy and sell federal funds futures contracts still do not expect that the FOMC will cut its target for the federal funds rate at its next two meetings. (We discuss the futures market for federal funds in this blog post.) Today, investors assigned only a 29.9 percent probability that the Fed’s policymaking Federal Open Market Committee (FOMC) will cut its target from the current 4.25 percent to 4.50 percent range at its meeting on May 6–7. Investors assigned a probability of 85.2 percent that the FOMC would cut its target after its meeting on June 17–18 by at least 0.25 percent (or 25 basis points).
By the time the FOMC meets again in early May we may have more data on the effects the tariffs are having on the economy.
Supports:Microeconomics and Economics, Chapter 11, Section 11.5, and Essentials of Economics, Chapter 8, Section 8.5
Image generated by ChatGTP-4o showing the costs of inputs to a factory.
Mickey, the Econ Pup, sometimes struggles with drawing and interpreting cost curves. Examine the cost curves shown in images a. and b. and let Mickey know if you find any errors.
a.
b.
Solving the Problem Step 1: Review the chapter material. This problem is about drawing and interpreting cost curves, so you may want to review Chapter 11, Section 11.5, “Graphing Cost Curves.”
Step 2: Answer part a. by explaining whether there are any errors in the cost curves shown in the image in a. No wonder Mickey is confused! This figure has multiple errors:
It’s an error to have the ATC and AVC curves cross. The unlabeled curve at the bottom is supposed to be AFC. We know that if a firm has fixed costs, then the ATC and AVC curves will get closer and closer as the quantity increases and AFC becomes smaller and smaller. But because AFC will never decline to zero, ATC and AVC can’t be equal at any quantity.
The second error is related to the first error. We know that the MC and ATC curves should intersect at the quantity at which ATC is at a minimum. In this figure, the MC curve intersects the ATC curve at a quantity that is larger than the quantity at which ATC recaches a minimum.
The third error is related to the first two errors. The relationship between the three average cost curves should be ATC = AVC + AFC at every quantity. In this figure the relationship doesn’t hold at any quantity.
Finally, there is a dotted line from the point where the (unlabeled) AFC curve intersects with the MC curve down to the Q-axis. But that point has no economic significance.
Step 3: Answer part b. by explaining whether there are any errors in the cost curves shown in image b. Mickey can rest easy with these cost curve because, although the figure seems to be only partially finished, all of the cost curves are correctly drawn. The MC curve correctly intersects the AVC curve at the quantity at which the AVC curve is at a minimum. The instructor could finish the figure by labeling the bottom curve as AFC and by drawing an ATC curve above the AVC curve, with the ATC curve intersecting the MC curve at the quantity at which the ATC curve is at a minimum.
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