How Two Fed Directors Addressed Tariff Inflation Concerns

In April, during a period of heightened concern over tariffs in Washington and on Wall Street, Federal Reserve President Christopher Waller stood out for his unique perspective. Even as many economists were sounding alarm bells about a potential inflationary spiral akin to the 1970s, Waller maintained that the new tariffs would only lead to a temporary price spike rather than ushering in a lasting inflation problem.

By September, another Fed director, Stephen Milan, had come onboard with a detailed quantitative analysis that indicated the existing monetary policy was overly restrictive by about 200 basis points. Nine months after Waller’s initial assertions, the most recent Summary of Economic Prospects (SEP) made a clear statement: The Fed seemed to adopt a Waller-like, or even Milan-like outlook. With inflation hawks receding, data has begun to support the views of Waller and Milan.

This shift is evident in the statements of Chairman Jerome Powell. During a press conference on May 7, at the peak of tariff anxiety, Powell was noticeably cautious, mentioning the phrase “we don’t know” an astonishing 18 times while hinting that sustained tariff increases could lead to higher inflation.

However, by June 18, his tone had sharpened: he suggested there was a reasonable expectation that the impact on inflation would be short-lived, describing it as a one-time adjustment in price levels. Powell outlined specific conditions that would need to be in place for sustained inflation, including a tight labor market and unanchored expectations.

Thus, Powell’s language began reflecting Waller’s viewpoints. As summer unfolded and new data emerged, this initial framework proved to be accurate.

Milan’s Quantitative Insights

When Milan joined the board, he brought a level of analytical rigor to bolster Waller’s ideas. In his speech on September 22, he illustrated how shifts in immigration policy would likely decrease inflation by reducing demand for housing, subsequently lowering the neutral interest rate—the rate essential for maintaining stable inflation. Milan argued that as tariff revenues rise, national savings would increase, further reducing the neutral rate. He elaborated on how deregulation could enable potential output to grow faster than actual output, creating disinflationary momentum.

Critically, Milan clarified that trade policy primarily influences relative prices and isn’t a shock to aggregate demand. Unless there is a tight labor market or unanchored expectations—which, as it turned out, did not arise—a one-time price increase wouldn’t lead to ongoing inflation.

In September, when the Fed established its stance, Milan called for a 50 basis point rate increase instead of the 25 that was being discussed. The committee’s forecasts for the subsequent months seemed to justify his analysis.

Expected Effects That Didn’t Occur

From June to December, the Fed tracked indications of tariff-related inflation. Yet, these signs never fully appeared. The labor market continued to show steady cooling rather than overheating or crashing. Inflation expectations remained stable, and wage pressures diminished. The inflation rate in services kept trending downward toward a 2% target.

What happened to the anticipated tariff pass-through that many forecasters said would increase inflation by a few tenths? By December, Powell was discussing much lower figures—around “two-tenths or less,” which, in the grand scheme, is pretty insignificant.

Rental inflation unfolded as Milan had predicted. With housing demand waning due to immigration policies, rent inflation for new tenants dropped to about 1%, considerably lower than previously reported statistics.

The economic forecast summary for December laid out the numbers quite clearly. In September, inflation expectations were projected between 2.6% and 2.8% for 2026, indicating a persistent impact from tariffs.

However, by December, this upper prediction range had narrowed significantly, with the distribution now hovering around 2.4%. The median forecast for 2026 slipped from 2.6% to 2.4%, largely attributed to previous hawks revising their outlooks downward. Those most concerned about inflation due to tariffs made the most significant adjustments. The committee aligned more closely with the framework Waller had introduced in April and Milan quantified in September.

Intellectual Evolution

As the Federal Reserve navigated unprecedented trade policy shifts, it developed a theoretical framework (Waller), added quantitative support (Millan), kept a close eye on the data (Powell), and adjusted forecasts based on evolving evidence. The core insights that have emerged affirm that tariffs are primarily about relative price changes, not overall demand shocks. When a tight labor market, unanchored expectations, or excess demand aren’t factors, temporary price changes won’t lead to lasting inflation.

The Fed’s previous model, which was grounded in an anti-tariff bias and assumptions lacking evidence, exaggerated the expected pass-through of tariffs. It also misjudged modern dynamics, especially the competitive pressures to absorb costs.

Milan’s calls for proactive adjustments seemed bold at that moment, asserting that taking action was more sensible than simply waiting. His analysis revealed that the policy was off by 200 basis points once the neutral interest rate adjustments were factored in. Just three months later, the committee began moving in his direction.

As December approached, Powell articulated that “if we end the tariffs, inflation will settle in the low 2s.” This supported the theory of a one-time price change. Tariffs could only influence prices once, without altering the underlying inflation trend.

Looking ahead, it appears that the Fed anticipates limited future inflation pressures. The normalization of policy may continue, with forecasts for inflation at 2.4% for next year and 2.2% in 2027. The hope for a soft landing persists.

Waller and Milan were correct about the economics when it mattered. Waller’s early optimistic stance in April and Milan’s quantitative backing in September culminated in December with the Fed aligning with their perspectives. Data has been the driving force behind this evolution.