Federal Reserve Governor Christopher Waller was interviewed on Fox Business this morning where he is hopeful that lower tariffs won’t affect the economy as negatively, but at the same time, he hopes the Administration’s movement towards long-term tariff settlement levels will allow for the Fed to start easing soon. My comments are in square brackets []. An exchange on rate cuts,

Edward Lawrence: On rate cuts; the Federal Reserve President, Raphael Bostic says one rate cut this year. Where are you on rate cuts?

Christopher Waller: Well the economy, if you look at the hard data, the economy is [inaudible, sounds closest to ‘doing’] quite well. We haven’t seen a lot of effect from tariffs yet, but from everything I’ve heard talking to CEOs around the country, there’s going to be some [inaudible, sounds closest to ‘ugly’] stuff coming, both in the form of prices going up…how much is not clear. If they can get…if Secretary Bessent can make sure to get a lot of trade deals where these things are closer to 10%, the standard rule is we can handle this. That’s the standard thing. But very high tariffs are going to be much more disruptive to the economy. So, if we can get the tariffs down to closer to 10%, and then that’s all sealed, done, and delivered somewhere by July, then we’re in good shape for the second half of the year, and then we’re in a good position at the Fed to kind of move with rate cuts through the second half of the year.

Waller didn’t finish his thought on what other [ugly] stuff is coming but one can presume from the common narrative at the Fed that the other effect from tariffs is lower demand. This is a shift from Waller’s last speech on 4/16 [covered here], where he was looking at a higher effective tariff rate of 25% and imagining that higher tariffs may cause a sooner breakdown in the labor market requiring rate cuts. After the “tariff climbdown” with China on May 12th, which brought the effective tariff rate down to 17.8% from 28% (Yale Budget Lab), it gives him hope of getting tariff rates settled by the end of the 90-day pause windows (July 9th for most of the world ex. North America and August 12th for China) which would then allow the Fed to start cutting rates naturally (i.e., not from an acute problem). Combining these ideas with his prior speech, he wants rate cuts with higher tariffs or with lower tariffs.

Then Waller pushes back gently on the oft-said idea that rate cuts won’t come before the end of the summer:

Edward Lawrence: So you’re not seeing rate cuts maybe even through the end of the summer?

Christopher Waller: Well, like I said, we’re going to wait and see what these trade deals do and we’re going to have to wait and see what happens to the April 2nd tariffs that were postponed until July [9th]. We want to see if those are actually going to be reimposed or not. If they are, they are going to have much bigger impacts on inflation and put more of a handcuff on us to do anything with short-term rates.

I estimate that the overall effective tariff rate would go back up to 23% if 4/2 tariff levels were reimposed; ask if you want to see the analysis. In an exchange about the persistence of tariff inflation effects, he laid out a simple model for what tariffs may do to inflation,

Edward Lawrence: Tariffs, do you see a one-time price increase? The Federal Reserve chairman says he does. What do you see?

Christopher Waller: Yeah, I’ve been arguing this for over a year, since last June, that straight economics is this is a one-time price increase, it doesn’t cause persistent inflation, and the standard central bank playbook is you just look through this. You don’t overreact to it because you’re going to then raise rates, hurt the economy, for something that is just a one-time price effect. So, that’s been my view for well over a year, that we have to kind of look through this and I don’t think that there’s a lot of things in place that would cause it to be persistent.

Edward Lawrence: The 10% baseline to these tariffs will remain in place. Would that affect the economy long-term in terms of prices?

Christopher Waller: Yeah, it will have some passthrough. Most firms I talk to, there’s this kind of simple rule of thumb. You know, a third of it will be eaten by the supplier [foreign], a third of it will be eaten by the firm [retailer], and a third of it will be passed on [consumer]. So if, it’s a 10% tariff, imports are 10% of the price index, so 10% on 10% is a 1% increase the price level. That means only a third of it is going to get passed through. So, instead of something like 2.5% you might see something like 2.8%, but that’s it, and then inflation should start coming right back down.

Waller here reaffirms his thought that tariffs are a one-time price level increase and should be looked through partially because he doesn’t see “a lot of things in place that would cause it [inflation] to be persistent.” I hear this as a nod to the business cycle; that Waller sees the economy as otherwise disinflationary.

But then he lays out a simple model for what tariffs will do to the inflation rate. If a third of a tariff price increase is borne by the consumer and imports comprise 10% of the inflation index (estimated to be 11% from the San Francisco Fed), then a 10% effective tariff rate would have a 0.33% impact on inflation. His simple model is:

t: Inflation impact from tariffs, 0.33%
i: Percentage of consumer inflation affected by imports, 10%
r: Effective tariff rate, 10%
c: percentage of tariff price increase borne by the consumer, 33%

t=i*r*c

In his speech back on April 14th, he thought, with an effective tariff rate of 25%, “If underlying core PCE inflation were to continue at its estimated 12-month pace of 2.7 percent in March, that would mean inflation could reach a peak close to 5 percent on an annualized basis in coming months if businesses quickly and completely passed through the cost of the tariff. Even if the tariffs were only partially passed on to consumers, inflation could move up to around 4 percent.”

But now, with the concept that the effective tariff rate is coming down and only a third of it is passed through to consumers, 5% inflation fear has quickly turned into 2.8%. Even with the effective tariff rate staying where it is now at 17.8%, it would imply an inflation rate peak somewhere around 3.2% with the other assumptions. With April 2nd tariffs being re-imposed (23% effective tariff rate, self-calculated), it would imply inflation rising to 3.4%; not impossible numbers to look through.

But then, with services disinflation (0.8% annualized over the last three months, more than twice the weight of imported goods, see table below) and/or the inability of retailers to pass-on even a third of price increases (as Home Depot indicated this week and has been Richmond Fed President Tom Barkin’s theme), inflation could end up only slightly changed even with an overall tariff rate >=10%.

In any scenario, Waller is trying to find a way to cut rates soon by providing an intellectual pathway to do so without jeopardizing the Fed’s inflation credibility. I suspect it is because he sees the business cycle coming. He is just one vote on the FOMC, but an influential one in Washington (a Governor) that has been pivotal before and an intellectual heavyweight.