The Federal Reserve hasn't met its 2% inflation goal in five years
Federal Reserve chief Kevin Warsh is trying to drag U.S. inflation back down to prepandemic levels. How long will it take?
After more than five years of failing to do so, Federal Reserve leaders think they can shrink the rate of inflation to 2% by 2029 with just slightly higher U.S. interest rates. Are they serious?
They are. And most economists and financial professionals are now inclined to believe them.
"We can definitely get to 2% inflation in two years' time," said chief economist Gregory Daco of EY Parthenon.
The initial step was the first increase in interest rates in three years, and it came under a new chairman picked by President Donald Trump, who has demanded the Fed slash borrowing costs instead. Kevin Warsh, who took the helm at the central bank in May, regained badly needed credibility with the hike after a shaky start to his tenure.
Warsh and the Fed still need a lot of help, however.
The effects of the Trump administration's 2025 tariffs have mostly faded, but flareups in trade disputes like the one with Canada could create additional roadblocks on the path to 2% inflation.
The protracted war with Iran also has to end to allow oil and gas prices to return to relatively low preconflict levels. Surging energy prices pushed the rate of inflation above 4% again in the spring and are probably the biggest obstacle for the Fed.
Quickly getting back to 2% might sound improbable, but many economists point out that the yearly rate of inflation, using the Fed's preferred price gauge, had slowed to 2.3% in April 2025, just as Trump's tariffs upended a decades-old global trading system.
"The Fed was on track to get to 2% before the tariffs," said Stephen Douglas, chief economist at NISA Investment Advisors. "We think inflation is going to return to the low 2% range over the next few years largely on its own."
Warsh rights the ship
Just a month ago, Wall Street had plenty of doubts.
In his first few months on the job, Warsh insisted the central bank would return the U.S. to an era of low inflation like the one that persisted before the pandemic. Yet he also seemed reluctant to take the necessary steps.
All of that began to change a few weeks ago. First Warsh gave a big speech at the end of August signaling he was unhappy about stubbornly high inflation. Investors took that as a cue he really would raise interest rates.
Then on Wednesday, the Warsh-led Fed pulled the trigger, raising a key short-term interest rate for the first time since mid-2023 and signaling at least one additional rate hike - and possibly more - to come.
Higher interest rates are a time-tested tool to tame inflation. By raising borrowing costs, they slow the economy and ease demand for goods, services and labor.
One rate hike alone, or even two, probably won't be enough to slay the inflation beast, given the tail effects of the tariffs and high oil prices. What mattered most on Wednesday was that Warsh gave Wall Street a reason to believe he was serious.
"Whether the Fed or investors think 2% [inflation] is attainable is secondary to his message," said Will Compernolle, macroeconomic strategist at FHN Financial. "He was able to convince markets he was going to do what it takes to bring inflation down."
Supply and demand
Whatever Warsh's intentions, higher interest rates can only do so much.
The most recent bout of high inflation, like runaway prices in the pandemic era, is the result of what economists call "supply shocks." And supply shocks are almost impossible for the Fed to control, as Warsh admitted.
"We cannot affect any individual price, whether it be oil prices, whether it be foodstuffs at the grocery store," he said Wednesday after the Fed rate hike was announced.
The tariffs, for instance, made it more costly for businesses to obtain supplies. And the partial closure of the Strait of Hormuz reduced the supply of oil around the world.
"Interest rates can cool demand. They cannot lower a tariff, reopen a shipping lane, or bring down the price of a barrel of oil," said Elizabeth Pancotti, a former Fed researcher and a senior executive at Groundwork Collaborative.
What the Fed can influence is demand. Warsh said the Fed raised rates to try to prevent the effects of tariff- and energy-induced inflation from spreading too deeply to other goods and services.
"What we can do and will do is ensure that any change in relative prices don't broaden out, don't have second- and third-order effects on the economy," he said.
What next?
Just how much does the Fed have to raise rates, or borrowing costs, to contain the spillover effects from supply shocks? That's where the consensus on Wall Street breaks down.
The Fed itself appears to be signaling that it will only require one more increase, and no more than two, to accomplish the job.
"We think one more will do the trick," said Sal Guatieri, senior economist at BMO Capital Markets. "We are not seeing lots of inflationary pressure outside of these supply shocks."
Take the labor market - traditionally a chief conveyor of high inflation. Labor costs are muted and have not been a big contributor to rising prices since the pandemic.
The cost of goods, meanwhile, has settled down after a big pop when the tariffs were first put in place. Prices of goods minus energy and food rose 0.7% in the 12 months that ended in August, down from a peak of 1.5% one year earlier.
For most of the last 15 years, goods prices usually declined each year, helping maintain low inflation.
"We see goods inflation going back to something negative," said Douglas of NISA.
The biggest source of inflation is services, and the rate of increase there has also slowed to close to prepandemic levels. Smaller increases in rents and home prices, the biggest expense for most people, are a big reason for that.
Aggressive strategy
Not everyone is convinced the Fed can wrestle inflation down to 2% with just one more rate hike. Some say it could take three or four increases.
Wall Street investors, for instance, are forecasting three more rate hikes between now and April, according to the closely followed FedWatch tool.
Alex Pelle, senior U.S. economist at Mizuho Securities, said the Fed has another problem: Inflation is not just rising because of supply-related issues tied to tariffs and oil.
The U.S. economy is also growing fast enough, he said, to drive up inflation through the normal demand channels: consumer spending and business investment, especially the boom in artificial intelligence.
"Demand is also excessive," said Pelle, who believes the economy is sturdy enough to absorb higher rates. "It's not going to go away completely on its own."
A more aggressive approach to raising interest rates would underscore the Fed's urgency to get to 2% inflation sooner rather than later.
Some analysts doubt Warsh is willing to wait two or three years to achieve that goal, based on his recent tough talk and his pre-Trump history of favoring an aggressive approach to fighting inflation.
"I have a hard time believing that Chairman Warsh will have that much patience for above-target inflation," said Stephen Stanley, chief U.S. economist at Santander Capital Markets.
Risk to the economy
That is exactly what worries a smaller but still sizable group of economists such as Daco of EY Parthenon. They contend the economy is not as strong as it looks.
A super-aggressive Fed bent on quelling inflation, Daco said, could deliver a stinging blow to the U.S. economy or even cause an outright recession. In such a scenario, the Fed would get to 2% inflation even more rapidly, but at the cost of millions of Americans losing their jobs or businesses.
"The Fed did not say the quiet part out loud," Daco said. "The reality is, the Fed is raising monetary policy to destroy demand to bring underlying inflation under control."
What would help the Fed avoid overshooting is a quick end to the Iran war and a drop in oil prices, but the conflict has already dragged on for more than six months.
"This is the big wild card for the Fed," Guatieri of BMO said. "The Fed can't ignore that."
-Jeffry Bartash