Former Richmond Fed President Lacker on February PCE data: The Fed is in a vulnerable spot

Key Concepts

• Inflation stickiness
• Federal Reserve (The Fed) vulnerability
• Inflation expectations
• Tariffs and their impact on inflation
• Economic uncertainty
• Consumer and business outlays
• Stagflationary shock
• Productivity growth

Inflation and the Federal Reserve's Vulnerable Position

The discussion centers on the latest inflation data, particularly the core year-over-year PCE, which is proving to be "stubborn" and not declining as hoped. Jeffrey Lacker argues that the Federal Reserve is in a "vulnerable place" with inflation stuck around 2.75%, potentially even higher. Wage gains have not fallen to a level consistent with the Fed's 2% target.

• Key Point: The Fed's past experience with a significant inflation bulge in 2021-2022, despite 25 years of good inflation experience, has potentially weakened the anchoring of long-term inflation expectations.
• Argument: Lacker expresses concern that the Fed might not be as confident that longer-run inflation expectations will remain anchored if inflation breaks away on the upside due to tariffs. He is "not so confident" that tariffs are something that can be easily "looked through."

Economic Uncertainty and its Impact on Spending

The conversation shifts to the broader economic uncertainty and its potential impact on consumer and business behavior.

• Analogy: Harkin's analogy of a "fog so steep you pull over and put on your hazards" is used to describe the current economic climate, suggesting extreme uncertainty and a need for caution.
• Lacker's agreement: Lacker agrees with the analogy, stating, "I'm on the shoulder. My hazard lights are blinking for sure."
• Historical Example: The 2008-2009 recession is cited as an example of how fear and uncertainty, triggered by events like the Lehman Brothers collapse and statements about a potential "Great Depression 2.0," can cause people to "go to the sidelines" and postpone spending.
• Concern: Lacker expresses concern that the "overwhelming sense of uncertainty" about the administration's program and the configuration of taxes and tariffs could lead people to postpone discretionary expenditures, hiring, and other outlays.
• Observation: While there has been a surge of activity to get ahead of tariffs, Lacker wouldn't be surprised to see people move to the sidelines in massive amounts.

The Fed's Role in Managing Inflation Expectations and Tariffs

The discussion turns to the Fed's role in managing inflation expectations in the face of potential inflationary pressures from tariffs.

• Kevin Warsh's Argument: Kevin Warsh's Wall Street Journal piece is referenced, arguing that the Fed is not a passive player and has the ability to influence whether tariffs create broader inflation by setting expectations.
• Lacker's Agreement: Lacker agrees that the Fed should be "talking tougher now" to set expectations and make it clear that it will address inflation if it arises.
• Stagflationary Shock: He describes tariffs as a "classic sort of stagflationary type of shock" that imposes a "nasty short run trade off" on the Fed.
• Offsetting Pricing Weakness: To keep the overall price level stable, the Fed would need to create "offsetting pricing weakness" elsewhere in the economy, which would involve "some pain" and a costly transition.
• Warning about Productivity: Lacker believes the Fed can warn that the evidence suggests tariffs are likely to reduce productivity growth by limiting competition in protected industries, reducing incentives for innovation, cost-cutting, and efficiency.

Conclusion

The main takeaways are that the Fed is in a vulnerable position with sticky inflation, and the potential for tariffs to exacerbate the situation is a significant concern. Economic uncertainty could lead to reduced consumer and business spending. The Fed needs to actively manage inflation expectations and be prepared to address any inflationary pressures from tariffs, even if it means short-term economic pain. The long-run effect of tariffs is likely to reduce productivity growth.