If President Donald Trump follows through on his proposed tariff hikes, consumer inflation expectations could rise sharply, complicating the Federal Reserve’s plan to cut interest rates.
The alarm came from Goldman Sachs, which unveiled that while the direct inflationary impact of tariffs may be modest, history suggests that consumers could perceive a broader and more persistent effect, making the Fed’s job trickier than during past trade wars.
In a note shared Friday, analyst Manuel Abecasis examined the potential consequences of a new wave of tariffs, estimating that a universal 10% tariff could trigger a one-off boost to headline inflation by up to 1 percentage point in the worst scenario.
Yet, the greater concern for policymakers is the potential rise of inflation expectations, which the Fed has previously warned could drive longer-lasting price pressures.
Will Tariffs Actually Drive Inflation Higher?
Goldman Sachs expects the incoming administration to raise tariffs this year, delivering a one-time inflation boost of 0.3 percentage points in the baseline scenario and 1 percentage point in a more extreme case.
However, the bank does not expect tariffs to immediately translate into a rise in inflation but rather to slow its current declining trend.
“In our baseline scenario, tariffs would cause inflation to fall by less than it otherwise would, but not rise from its current rate,” the note said.
The Fed indicated that it would likely overlook temporary tariff-induced inflation, as it did during the 2018-2019 trade war.
Yet, Fed Chair Jerome Powell signaled at the December press conference that the situation is different this time because the U.S. has “just been through a period of high inflation.”
This distinction is crucial because inflation expectations have risen recently, particularly in the University of Michigan’s consumer survey. Some respondents have already cited potential future tariffs as a reason for adjusting their inflation outlook.
The Power Of Inflation Expectations
Economists widely agree that inflation expectations influence actual inflation. If businesses and consumers believe prices will rise, they may increase wages and adjust spending behaviors accordingly, creating a self-fulfilling cycle.
Goldman Sachs outlined two reasons why tariffs could have a larger effect on expectations now than during the 2018-2019 trade war.
First, the potential tariff increases are expected to be larger than before.
Second, the memory of recent inflation is still fresh. Research shows that people who have lived through high inflation are more likely to expect it to persist, reacting more aggressively to price changes.
Salient price increases, such as gasoline, which consumers encounter daily, also tend to have an outsized effect on expectations.
Put it simply, if Americans believe that inflation is here to stay, their expectations could shift, triggering behaviors, such as businesses preemptively raising prices and workers demanding higher wages, that could keep inflation stubbornly high.
Goldman Sachs analyzed University of Michigan survey data, confirming that both recent and old inflation experiences strongly shape individuals’ expectations.
The report found that consumers react more sharply to price changes in highly visible categories like gasoline, suggesting that widespread media coverage of tariff-driven price hikes could amplify inflation fears.
“Under a 10% across-the-board scenario in which the tariffs are highly salient to consumers, short-term inflation expectations would be 0.9pp higher and long-term inflation expectations would be 0.25pp higher than in the no-tariff case,” Abecasis wrote.
“Such a scenario might restrain the FOMC from cutting, though high public awareness of tariff-driven price increases might also restrain the White House from continuing to raise tariffs,” he added.
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