In the Market-How the ghost of ‘transitory' inflation is haunting the rate debate

Reuters

22-07-2025

July 22 (Reuters) - Joseph Lavorgna, counselor to Treasury Secretary Scott Bessent, believes tariffs are not inflationary and says economists who have been predicting that prices would rise due to President Donald Trump's import duties are wrong.
Where many such economists saw effects of tariffs in consumer price inflation data last week, Lavorgna was not persuaded. Economists had been predicting tariffs would show up in numbers month after month, but the data in aggregate has remained muted, he said.
'Almost every economist has gotten it wrong,' Lavorgna told me, and added that he and his colleagues in the administration felt that mainstream economists' analyses had been clouded by political bias.
At any rate, he said, inflation is a perpetual rise in prices, rather than a one-time increase in price levels. 'To the extent there is a negative effect -- which we have yet to see -- it would be a one-off price level adjustment,' he said.
Lavorgna's comments underscore how a debate over inflation is once again turning on the question of whether any price rise from Trump's tariffs would be fleeting or not. It's an echo of what happened after the COVID-19 pandemic, when the Fed thought inflation was transitory – and it turned out not to be.
Now, while some administration officials and Fed governors expect any impact from tariffs to be temporary, other economists and market participants remain convinced that the president's conventional wisdom-defying policy could lead to bad outcomes, like slower growth and inflation.
These people want to see more data as they argue that there are still many unknowns around inflation – it could rise in the coming months as much uncertainty remains around what the final tariffs would be; price increases could spill to other areas; and tariffs could cause inflation expectations to rise. There are also many unknowns about the eventual impact of the import duties – and other administration policies like those on immigration – on the economy.
'Even if you think of this as a one-time increase in costs, what is more likely to happen is that firms are not going to pass it on all at once,' said Alberto Cavallo, a Harvard University professor who has built a model to track the price impact of tariffs. 'They're going to do it gradually. And that gradualness tends to push inflation upward for a significant amount of time.'
My colleagues at Reuters have developed a tracker to see how companies are responding to tariffs.
What happens with inflation is of immense importance all around -- to global markets, investors and consumers, who endured hardship as easy monetary policies and supply chain disruptions following the COVID-19 pandemic led to inflation levels not seen in more than a generation. Unhappiness with high prices was as one of the reasons behind Trump winning the presidential elections.
Trump has directed his ire over the disagreement on rates most intensely against Jay Powell, the Federal Reserve chair, leading some investors to worry about the independence of the central bank.
With Trump calling for the central bank to cut rates by as much as 3 percentage points while the economy is still holding up, the risk, some economists and investors say, is that such a stimulus would bring a repeat of what happened after the pandemic.
'It makes sense for the Federal Reserve to wait and see before they make a big decision,' Cavallo said.
Cavallo's research, which is updated frequently to account for the changes in Trump's tariff levels, analyzes pricing on the websites of four large U.S. retailers. As of July 14, the analysis found 'rapid pricing responses, though their magnitude remains modest relative to the announced tariff rates and varies by country of origin.'
The findings echo other attempts to unpack what's happening behind aggregate inflation numbers. A paper in May by Fed economists dug inside a closely watched inflation gauge called PCE. It showed tariffs on Chinese imports in February and March had already affected consumer prices.
The administration, too, has done its own analyses and published a counterview to these findings earlier this month. Using techniques similar to the Fed paper, the Council of Economic Advisers, the White House's think-tank, found that prices of imported goods had fallen this year.
None of the papers provide a comprehensive view of what's happening, however, and acknowledge various limitations of their findings.
The debate over the effect of tariffs is also starting to divide Fed officials. Fed Governor Chris Waller, who is seen as a potential candidate to succeed Powell, for example, favors a rate cut at the July meeting because he feels the tariffs are likely to have a limited impact on inflation, and he is concerned the economy and private sector hiring are starting to slow. Others, like New York Fed President John Williams, have professed caution, saying it was still early days.
"Comments coming from Fed officials suggest that the FOMC is cleaving," Thierry Wizman, Global FX & Rates strategist at Macquarie Group, wrote in a note on Friday, referring to the central bank panel that sets monetary policy. Should it persist, it could "evolve into a split along political lines, with one side swayed by political motives, and the need to accommodate fiscal policy, at the expense of adherence to the price stability mandate."
"This would contribute to U.S. yield-curve steepening," Wizman wrote.
​