Though the Trump administration inherited a strong economy, in under three months, it has generated a steep stock market sell-off and deep concerns about where things are headed. The market losses Thursday and Friday were worse than 99.9% of all trading days since 1929, and Monday morning brought even further declines. This historical sell-off was without doubt the result of Trump’s big “Liberation Day,” when he revealed a set of tariffs that raises the average U.S. tax on imports to levels not seen in almost a century.
Tariffs of this magnitude pose an especially tough challenge for the economy. Because they are largely passed forward to consumers, they raise prices. And because they similarly raise the price of inputs for domestic producers — 45% of our imports are “intermediate goods” — they raise the cost of production, which hurts growth. Add to these woes the tremendous uncertainty created by Trump’s on-again, off-again policy lurching, along with the aforementioned market meltdown, and you understand a) why both consumer and investor sentiment has fallen off a cliff, and b) why economic forecasters have lowered their growth expectations and raised their inflation forecasts.
Faced with stagflation, what’s a central banker to do?
This combination of lower growth and faster inflation is called stagflation, and it is a particular challenge for the Federal Reserve. To counteract slower growth, Fed officials can lower the benchmark interest rate they control. But to counteract inflationary pressures, they typically raise rates. Faced with stagflation, what’s a central banker to do?
Their best play is to leave rates where they are until it is clear which problem requires addressing with a rate change. In fact, that’s just what Federal Reserve Chair Jerome Powell said Friday. Given that the appropriate path for Fed policy is “not clear at this time,” he said, “it feels like we don’t need to be in a hurry.”
So, what’s the problem? Well, here’s what the president posted on Truth Social that same day, as the stock market was tanking: “This would be a PERFECT time for Fed Chairman Jerome Powell to cut Interest Rates. He is always “late,” but he could now change his image, and quickly.”
“CUT INTEREST RATES, JEROME, AND STOP PLAYING POLITICS!” Trump concluded.
Now, to understand what’s going on here, we need to go back to one of Powell’s predecessors, Alan Greenspan. Under Greenspan, the Fed was so consistent in cutting rates as soon as the market softened that investors came to depend on the Fed chair to protect them from bear markets. This was known as the “Greenspan put,” a reference to a financial tool by which an investor is protected from downside losses.
To be clear, I’m not saying Trump is an avid student of monetary history. I am saying he wants and expects Powell to bail him out, and he know there’s a precedent for the Fed to provide a macroeconomic insurance policy against a policy shock, even if it’s Trump’s own doing.
If you let the president oversee the central bank, the risk that he will force it to overly juice the economy is just too high.
His post also reveals that he’s clearly uninterested in a guiding principle of past administrations, including the Biden presidency, during which I chaired the Council of Economic Advisers. When I was asked about Fed policy, with zero exceptions, my answer was to say nothing. Well, not exactly nothing, but nothing more than this: “We don’t talk about Fed policy because we are fully committed to Fed independence. History is littered with examples of economies severely damaged by the inflation unleashed by pressuring the Fed to cut rates.” In fact, at CEA, we published a detailed defense of this stance, showing the historical importance of Fed independence, especially to control inflation.
It’s common sense. If you let the president oversee the central bank, the risk that he will force it to overly juice the economy is just too damn high.
There’s one more important wrinkle here for the Fed to consider. Because a tariff is a tax that takes effect at a point in time and stays on until it’s lifted, it does raise prices, but it does so just once. You get a spike in inflation over a month or two, and then inflation drifts back to where it was pre-tariff. Economists call this a “one-time rise in the price level” versus a permanently higher inflation rate. The Fed probably doesn’t like that anymore than you or I do, but as long as inflation doesn’t stay elevated, it doesn’t have to raise interest rates to get it back down. That could work to Trump’s advantage — unless the tariffs just keep coming. Remember, the scenario I just outlined requires one and done. But if Trump keeps lurching around the way he has since he got back into office, the producers, businesses and employers who set prices and wages in the economy are going to expect ever-higher price pressures. This is a huge problem for the Fed that deeply depends on inflationary expectations remaining “anchored.” A one-time hit doesn’t dislodge the anchor. But repeated hits definitely can. As Powell said Friday, “While tariffs are highly likely to generate at least a temporary rise in inflation, it is also possible that the effects could 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.” The upshot is that Powell and the Federal Reserve must ignore Trump, maintain independence, watch what happens to both policy and inflation, and raise or lower rates as they see fit. But ignoring Trump is a lot easier said than done. Especially if the markets keep tanking, Trump will demand a “Powell put” with increasing fury. But the Fed chair is unquestionably right about tuning Trump out, and those of us who speak on such matters should give him all the backup we can.
Jared Bernstein was chair of President Joe Biden's Council of Economic Advisers. 
