Writing last year about the expected economic policies of a newly elected president, I thought that the Federal Reserve (aka the Fed, U.S. central bank) would have to see the direction of the fiscal policy before any new decisions on interest rates.

Things, however, turned out considerably more complicated because a radical change of foreign trade – introduced by the new administration -- became an essential instrument for raising American tax revenues.

The Fed, therefore, will have to consider the impact of higher trade tariffs on income, employment and inflation. American consumers will now have to pay higher prices for some $3.3 trillion of imported goods and services. Rising inflation will follow, and that will cut the households’ real purchasing power.

The cumulative effect of those price and income changes will reduce consumer spending. And that, in turn, will slow down economic growth, bringing job losses and increasing unemployment.

For the Fed, those are crucially important considerations to properly execute its difficult policy mandate of “maximum employment and price stability.”

The Fed’s “wait and see” is correct

The key problem is that the outcome of ongoing tariff negotiations is highly uncertain.

So far, higher trade tariffs have been largely settled only with Canada and Mexico, which account for 30% of the U.S. merchandise trade. Negotiations are still going on with the E.U. and China, whose bilateral trade with the U.S. accounts for 18% and 11%, respectively. The remaining 40% of U.S. foreign trade is a completely uncharted territory.

Given those uncertainties, the Fed now seems reluctant to change the policy settings of a reasonably stable economic activity.

Headline and core consumer prices in March -- 2.4% and 2.8%, respectively -- have come down close to the medium-term inflation objective of about 2%. Market segments showing price tensions, such as food and services, need specific policy actions to relieve supply shortages rather than broad spectrum interventions of credit restraint.

Labor markets are also well balanced. With a jobless rate of 4.2% in March – roughly unchanged from the year ago – the U.S. is a fully-employed economy.

The first estimate of American GDP growth in the first quarter of this year will be published next week (April 30). That will offer a clear view on the current state of all aggregate demand components. And public sector accounts will show what kind of fiscal policy the Fed will have to work with to appropriately calibrate its own credit stance.

Rate cuts now will add oil to fire

Unfortunately, risks and uncertainties of trade negotiations are profoundly destabilizing the U.S. economy. And there is nothing the Fed can do about it.

The best thing to do is to seek a quick resolution of the U.S. trade policy.

That, however, is a tall order.

Trade issues with the E.U. are bound up with the war in Europe where U.S. and European positions are dangerously opposed. In fact, those positions are now at the breaking point, with the U.S. pushing for a speedy peace settlement while the E.U. urges a continuation of hostilities.

At stake is the security architecture of the trans-Atlantic community that provides the foundation to economic, political and social ties holding together the world’s largest alliance.

Problems with China are much more serious. The symbolism of a Chinese airline refusing delivery of Boeing’s best-selling passenger planes shows that the damage to bilateral ties may well be beyond repair. The long-dreaded U.S.-China trade decoupling is under way.

And then there is a specter of war between nuclear-armed adversaries. The status of Taiwan, and clashes around China’s contested maritime borders with Japan and the Philippines – both are U.S. military treaty allies – are flashpoints where “accidents” and miscalculations can get out of control.

Under those circumstances, the Fed must work with the assumption that higher trade tariffs will lead to accelerating inflation, and that the ensuing loss of real purchasing power will depress consumer spending, business investments and employment creation.

But quantifying those assumptions to estimate their inflation impact is another difficulty. Foreign companies will not simply leave their hard-earned U.S. market shares. They may absorb large portions of trade tariffs to hold on to their American customers. In that case, segments of U.S. economy may experience inflation increases well below those implied by trade tariffs.

Nobody knows how much of that will happen. On balance, therefore, it is more reasonable to assume that sweeping import tariffs will accelerate the U.S. inflation.

Cutting interest rates in anticipation of such events, the Fed would just be adding oil to fire and setting the stage for a recession during Congressional mid-term elections in November 2026.