Former President of the Federal Reserve Bank of New York, Bill Dudley, warns that the U.S. economy faces the risk of stagflation.

After President Donald Trump announced a new tariff policy, the market experienced turbulence, and the economic outlook worsened. Bill Dudley, former President of the New York Federal Reserve, warned that the U.S. faces inflation and slowing economic growth, with stagflation being the best-case scenario. The Federal Reserve is caught in a dilemma between raising interest rates to cool down the economy and lowering them, which could worsen inflation, with internal disagreements over policy. The tariff policy has triggered global trade tensions, shaken market confidence, and raised the risk of an economic recession.

Stagflation: From the Worst Case to "The Best We Can Hope For"

In a media interview, Bill Dudley pointed out that with the Trump administration imposing high tariffs on China and other trade partners, the U.S. economy is facing the dual pressures of rising inflation and stagnant growth. He stated, "Stagflation was once considered worse than a recession, but in the current policy environment, this might be the most optimistic outcome we can hope for."

According to Dudley's analysis, if the Federal Reserve chooses to raise interest rates to curb inflation, it will further suppress economic activity; conversely, if it lowers rates to stimulate growth, it may lead to a spiral of rising prices. He warned that this is a "no-win situation," posing significant risks to the stock market and the overall economy.

The Federal Reserve's Policy Dilemma and Internal Divisions

Federal Reserve Chairman Jerome Powell recently admitted in a public speech that the current economic environment and policy choices are "more complex than the pandemic period." He noted, "Our primary task is to maintain price stability, but we cannot ignore the risks to economic growth."

However, there are clear divisions within the Federal Reserve regarding response strategies. Board member Christopher Waller has recently shifted to a dovish stance, leaning towards supporting rate cuts to address slowing growth; meanwhile, Michelle Bowman, nominated as Vice Chair for Supervision, publicly opposes rate cuts, arguing that controlling inflation should be prioritized. This division makes policy coordination more difficult and reflects the Federal Reserve's struggle between its dual objectives of price stability and full employment.

Economic Impact of Tariff Policies

In early April, the Trump administration announced a universal 10% tariff increase and imposed reciprocal tariffs on countries with trade deficits, with tariffs far exceeding market expectations. This move triggered retaliatory tariffs from major economies like the EU and China, risking the fragmentation of global trade order.

According to forecasts by Goldman Sachs and JPMorgan, the probability of the U.S. economy entering a recession in the next 12 months is 45% and 60%, respectively. JPMorgan further predicts that by 2025, U.S. GDP will shrink by 0.3%, and the unemployment rate is expected to rise to 5.3%. Meanwhile, the core Personal Consumption Expenditures (PCE) inflation rate may rise from the current 2.8% to 4.4%.

Federal Reserve Board member Adriana Kugler noted that recent increases in goods and services prices have partially reflected the anticipated impact of tariff policies. She emphasized, "Controlling inflation remains our top priority."

Market Reaction and Confidence Crisis

Following the policy announcement, the financial markets reacted swiftly. The three major U.S. stock indices entered a bear market, with the Dow Jones Industrial Average plummeting over 1,600 points in a single day, and the dollar index falling from 103.66 to 101.26. U.S. Treasury yields also declined, indicating a rapid collapse in investor confidence in the economic outlook.

Former Federal Reserve Vice Chairman Alan Blinder pointed out that the market's expectation for a rapid rate cut by the Federal Reserve is overly optimistic. He stated, "If the economy falls into a recession, the Federal Reserve may cut rates, but there is currently no sign that they are ready to do so."

The CME Group's Fed Watch tool shows that the market expects the Federal Reserve to cut rates by as much as 100 basis points this year. However, both Powell and Vice Chairman Philip Jefferson have stated that the current policy stance is sufficient to address risks, and there is no need to rush adjustments.

Historical Shadows of Stagflation and Current Differences

Chicago Federal Reserve Bank President Austan Goolsbee stated in an interview with CNBC, "Nothing is more unsettling than stagflation; it is the most difficult scenario for the Federal Reserve to handle." He pointed out that high tariffs simultaneously drive up prices and suppress output, which is a typical stagflation shock.

Although current inflation and unemployment rates have not reached the extreme levels of the 1970s, "stagflation-like" economic traits are gradually emerging. Federal Reserve officials generally believe that if inflation expectations get out of control, it will force the central bank to raise rates in the future, further suppressing the economy.

References

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