Inflation remains elevated as tariff pressures begin to pass through to the consumer. At the same time, new employment data from the Bureau of Labor Statistics suggests that the job market is cooling more quickly than expected. This puts the Federal Reserve in the difficult position of navigating monetary policy at a moment when the U.S. economy is at a critical crossroads.

There is cautious optimism that inflation may ease in the months ahead, particularly if the recent tariff effects prove to be temporary. However, history warns that optimism alone is not enough. In the 1970s, the Fed faced a similar dilemma and eased policy too soon — allowing inflation to reignite and ultimately triggering a prolonged period of stagflation.

Stagflation describes a cycle of persistent inflation, rising unemployment, and stagnant growth, and it’s notoriously difficult to manage. The tools used to fight inflation and those used to stimulate growth often work at cross-purposes. Raising interest rates can cool inflation, but it also slows the economy and increases job losses. Cutting rates may boost growth, but it risks reigniting inflation.

The August Consumer Price Index showed headline inflation holding steady at 2.7% from June, but core inflation, which excludes volatile food and energy prices, rose to 3.1%, its highest level since February. Increasing costs in sensitive categories such as furniture, toys, apparel, and footwear indicate that consumers are starting to feel the impacts of tariff policy. Moreover, the Producer Price Index surged 0.9% in July, well above consensus expectations of a 0.3% month-over-month increase. 

Meanwhile, the nonfarm payroll figures released roughly two weeks ago paint a sobering picture of labor market softness. Not only was July’s job growth number weaker than expected, but significant downward revisions to May and June dramatically shifted the early summer’s perception of a stabilized labor market and provided more fodder to those who clamor for the Fed to begin cutting rates now.

The Federal Reserve is facing mounting pressure. The White House — and even two members of the Fed Board — are calling for a rate cut. The market seems to agree. According to the CME FedWatch tool, the probability of a 25-basis-point cut at the September meeting has risen to nearly 93%. However, the Fed has stated time and time again that it remains committed to a 2% target, and the resolve of some Fed officials to keep rates steady despite the risk of further employment weakening has likely only hardened because of the dramatic increase in the producer price index.

During the 1970s, the Federal Reserve initially raised interest rates to combat inflation. However, under pressure from the White House and Congress, it reversed course too quickly as the economy slowed, and unemployment rose. These premature rate cuts, combined with extensive spending and successive oil-price shocks, allowed inflation to reaccelerate and ushered in a prolonged period of stagflation that defined much of the decade. The tide only began to turn when Paul Volcker became Fed chair in 1979. Over just eight months, he raised the federal funds rate by 900 basis points to nearly 20%, a bold move that ultimately broke the back of double-digit inflation, though at the cost of a deep recession.

While today’s conditions are nowhere near as extreme as those in the 1970s, they share the uncomfortable similarities of persistent inflation and slowing growth, the very definition of stagflation. The Fed’s next move will send a powerful signal to markets and the broader economy. For now, inflation remains further from the Fed target than unemployment and is projected to rise. Oxford Economics forecasts core inflation could reach 3.8% by year-end as tariff effects continue.

With inflation data unlikely to bring clear direction anytime soon, especially amid ongoing tariff pressures, and labor market risks still manageable, many Fed officials may favor a wait-and-see approach.

Just as the summer heat eventually gives way to autumn’s cooler air, we can hope inflation will follow suit. But history warns that if the Fed relaxes its stance too soon, as it did in the 1970s, it risks repeating a stagflationary cycle that will force even more painful measures down the road.  

Economic Conditions: Then vs. Now

*Latest data from July 2025 nonfarm payroll report
Source: Federal Reserve Bank of St. Louis