By Elisabeth Buchwald, CNN
(CNN) — The Federal Reserve on Wednesday painted a picture of an economy reshaped dramatically by Donald Trump and his economic policy. It warned tariffs would slow the economy and raise inflation, increasing the risk of dreaded “stagflation,” an economic curse that is hard to escape.
Eager to soothe worried investors, businesses and consumers, the Fed urged caution about getting too worked up about its forecast, noting that inflation caused by tariffs may not be long lasting. Nevertheless, there’s no cocktail a central banker hates more than high unemployment mixed with high inflation.
That cocktail – stagflation – was in the limelight after the Fed’s March meeting.
While Wall Street was already starting to sound the alarm about stagflation, Fed Chair Jerome Powell has remained relatively sanguine. That held true at Wednesday’s post-meeting press conference.
But many market observers felt Fed officials’ new economic forecasts nevertheless gave off whiffs of stagflation.
According to officials’ latest median estimates, the US unemployment rate may hit 4.4% by year’s end and inflation, as measured by the Personal Consumption Expenditures price index, could rise to 2.7%.
That’s an uptick from the 4.3% unemployment rate and the 2.5% inflation rate officials projected in December. It’s also a jump from the current 4.1% unemployment rate, per the February jobs report, and 2.5% PCE inflation in January.
Additionally, US gross domestic product, Fed officials predict, will grow at an annual rate of 1.7%. In December, Fed officials projected a 2.1% pace.
In a note to clients on Wednesday, JPMorgan chief US economist Michael Feroli said the projections “were revised in a stagflationary direction.”
If the Fed’s latest forecasts manifest, though, they’ll be a far cry from stagflation.
Stagflation explained
Stagflation is the ultimate doomsday scenario for central bankers. No matter what they do, it’s all but certain to inflict pain on the economy.
Low rates of unemployment tend to compensate for some of the pain that high levels of inflation bring because businesses generally can only raise prices when people are earning enough to afford it. In contrast, when unemployment is high and people are cutting corners, businesses will have a tough time passing on higher prices to their customers, which keeps inflation low.
One of the worst bouts of stagflation happened in the 1970s after a spike in oil prices from the Arab oil embargo on the US and other countries that supported Israel in the 1973 Yom Kippur War raised the cost of living dramatically. But when the Fed tried to ease inflation by raising interest rates, the economy fell into a recession.
Then, to get the economy out of a recession, the Fed lowered interest rates. That resulted in higher inflation. Ultimately it took a painful recession without interest rate cuts to get the economy back on track.
What the economy is now experiencing, partially a result of President Donald Trump’s tariff policies dampening economic growth forecasts and renewing concerns about inflation, is unlikely to prompt Fed officials to so much as whisper stagflation to one another.
“I was around for stagflation. It was 10% unemployment. It was high single-digits inflation and very slow growth,” Powell said last May, referring to stagflation in the 1970s.
We’re nowhere near those 1970s levels now.
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