The higher-than-expected January indices for consumer prices and producer prices have reignited the debate on the Federal Reserve’s options to achieve price stability without hurting employment. Two Wharton experts delved into those issues on the Wharton Business Daily podcast (listen here): Nikolai Roussanov, finance professor, broke down the latest inflation trends. Peter Conti-Brown, professor of legal studies and business ethics, identified lessons from the Fed’s actions in previous episodes of high inflation.

Nikolai Roussanov on Inflation and the Fed’s Options

Immediate rate hike unlikely: The Fed may not raise interest rates unless inflation worsens alarmingly. The markets had reacted to the latest CPI (Consumer Price Index) data with the expectation that the Fed will pause rate cuts for even longer than perhaps was anticipated. However, they seem to be shrugging off the PPI (Producer Price Index) reading of 3.5% year-on-year.

How prices changed: While the core CPI for January 2025 grew at a higher-than-expected 3.3% year-on-year, the increase in the monthly rate took it to the highest level since April 2023. Some factors driving the latest inflation numbers were probably seasonal. Transportation services and shelter saw higher inflation. That is concerning for the Fed and consumers.

Through the lens of the Fed: The Fed closely tracks the Personal Consumption Expenditure Price Index, which for January will probably be a bit lower than CPI at 2.4-2.5%. That will give the Fed enough cover to continue easing maybe sometime in the fall.

The Fed pays attention to primarily employment; the other leg of its mandate is price stability. The unemployment situation is healthy at around 4.1% since last fall. Unemployment insurance claims have been going up and down the last few months. But there is nothing indicating any serious weakness in the labor market, unlike last August-September, when it looked like employment was softening and maybe the Fed was not cutting rates fast enough.

On the flip side, the real incomes of many Americans have not caught up yet with inflation in the post-COVID years. So, many people feel the economy is not as good as they had hoped for.

Where are interest rates headed? The Fed is facing a very delicate balance here. They would like to keep employment or unemployment roughly at where it is now, while bringing inflation down. If they have to resume rate hikes to combat rising inflation if it picks up again, that will do some damage to employment. However, it’s highly unlikely that they will go that route, unless inflation accelerates in the coming months.

“There is nothing indicating any serious weakness in the labor market, unlike last August-September, when it looked like employment was softening and maybe the Fed was not cutting rates fast enough.”— Nikolai Roussanov

The price of unknowns: There are many unknowns in the mix. There’s uncertainty about tariffs, and about tax cuts and deficits. All of those will weigh on the expectations of consumers, investors, and firms. Firms are already raising prices, just based on the expectation of tariffs. Metals futures are up between 5% and 7% since the talk of the tariffs on steel and aluminum. That will reverberate throughout the economy. Shelter will not become cheaper if construction gets more expensive.

Peter Conti-Brown on Lessons from Prior Fed Actions

Inflation seesaw: Even as the Fed kept rates near zero after the 2008 financial crisis, a return to full employment was agonizingly slow. Inflation spiked again after COVID, and has yet to reach the Fed’s long-term inflation target of 2%. Many issues facing the economy are structural and have nothing to do with the central bank. But central bankers must also engage in some soul-searching.

Painful inflationary episodes: The Fed went through an extraordinarily painful period, from 1965 roughly until 1984, where inflation was temperamental; it was sky-high in the late ’70s and the early ’80s. It was very hard to calibrate monetary policy relative to the inflationary environment they were encountering. That was a global phenomenon, and there were some non-U.S. contributors to it, such as the OPEC-led oil embargo in response to war in the Middle East. But virtually everybody agrees that the Federal Reserve policy during that period was just wrong.

The Fed went through a rather searing episode in the years after the Great Financial Crisis of 2007-2008. In the post-crisis era, interest rates were stuck at the zero lower bound from November 2008 through December 2015. Yet, we didn’t get the post-recession bounce-back to full employment. It was just agonizingly slow. That left millions of people demoralized, trying to get a job and failing.

The year 2020 was a period of extraordinary experimentation inside the Fed. They dusted off the 2008 playbook and injected so much monetary stimulus and liquidity. What’s astonishing is how successful that was. The employment rate reached full employment faster than anything we’d ever seen in history. We had unemployment spike sky-high, and then collapse. We had stimulated the economy with unprecedented stimulus packages.

“Central bankers see their role as being entirely focused on the long-term health of the economy without any other kind of distraction.”— Peter Conti-Brown

Stimulus overkill? The Federal Reserve is now starting to see early signs [of worrisome inflation]. Everybody described the post-stimulus inflation as transitory, and that it would work itself out. In hindsight, that looks obviously wrong. The Fed might be asking itself: “Wait, did we overdo it?”

Economists are still debating the nature of this inflation. It shot up, came back down, but is still with us. It’s not reaching back down to that 2% target.

The Fed has had to pivot and pivot again and try to be nimble and flexible. Come 2022, they found themselves a little bit flat-footed for the first time since the Volcker era. (Volcker, who was Fed chair from 1979 to 1987, tamed runaway inflation with stiff interest rate increases, but they also caused two recessions.)

On Fed independence: Central bankers see their role as being entirely focused on the long-term health of the economy without any other kind of distraction. But all politicians are going to be focused much more on the next election than they are on the state of the economy 10 years from now. Fed independence does a pretty good job of wresting the attention from politicians from the immediate term to that medium term.

But the biggest problem is that central bankers are making value judgments about how to prioritize different aspects of their remit. Their remit is written by politicians. Congress is their boss. The central bankers themselves are appointed by politicians, picked by the President, and confirmed by the Senate.

But just because it suffers from what theorists like me call a democratic deficit, this is not a democratic institution. That does make it imperfect. If it’s compared to central bankers who take an oath of loyalty to a person, as opposed to policies, then what we have right now is not just better than the alternative, it’s much better. In that sense, we’d want to preserve it.