President Trump’s tariff announcements have simultaneously raised inflation expectations and dampened economic prospects—so much so that former New York Fed President Bill Dudley wrote that “stagflation is now America’s best-case scenario.” Stagflation, the combination of high inflation and slow growth, is among the most difficult for the Federal Reserve to manage: contractionary policy may tame inflation but slows growth further, while expansionary moves risk fueling inflation without the guarantee of boosting the economy. Every option, in effect, becomes a double-edged sword.
The central bank is meeting on May 7 to determine its next step on interest rates. Currently, markets expect rates to stay the same after the May meeting but a 60 percent chance of a 25 basis-point cut in June, according to the CME Group’s FedWatch. Such expectations reflect “how they have been trained repeatedly by the Fed to expect looser financial conditions the minute there are any signs of unusual market volatility,” the economist Mohamed El-Erian wrote in a Bloomberg op-ed last week.
El-Erian, the former CEO of the investment management firm PIMCO, argued that the Fed should not cut rates too soon because “lessons from central banking history suggest that when faced with both parts of the dual mandate going against it, the Fed should give priority to putting the inflation genie back in the bottle.”
While the Fed must balance its dual mandate of keeping consumer prices in check and maximizing employment, controlling inflation takes precedence because, as Fed board member Adriana D. Kugler noted in April 2025, “expectations of inflation could be a driver of the conditions behind stagflation even if, all else being equal, economists see less trouble ahead.” For instance, when inflation expectations run high, business owners anticipate rising costs will eat into profits, making them less inclined to expand or hire. As a result, even lower interest rates may fail to stimulate growth if inflation persists.
El-Erian’s call for the Fed to prioritize inflation by keeping interest rates steady or elevated departs from market consensus, but the view is grounded in a history of successful central bank moves, as he noted. Paul Volcker, who led the Fed during the stagflation of the early 1980s, raised rates to 20 percent in 1981 to combat inflation that had reached 13.5 percent. It was a radical move by today’s standards, but it worked. By 1983, inflation was largely under control.
The Fed hasn’t announced a specific direction just yet. In an April 4 speech, Fed Chair Jerome Powell warned that tariffs will raise inflation and slow growth and said he will “wait for greater clarity before considering any adjustments to [the Fed’s] policy stance.”
Curbing inflation is especially critical given that the Fed enters the current economic turbulence with “credibility eroded by the misguided 2021 transition inflation judgment,” El-Erian wrote. After the U.S. emerged from Covid lockdowns and consumer prices surged, Powell described the inflation spike as “transitory,” expecting it to ease quickly. Instead, price increases persisted and remained stubbornly above the Fed’s 2 percent target, even after aggressive interest rate hikes.
With that credibility weakened, El-Erian argued, it’s all the more important for the Fed to demonstrate that it takes its inflation mandate seriously. To its credit, the central bank has so far avoided a knee-jerk reaction to recent stock market volatility and a growing inflow of recession expectations from Wall Street’s top economists.