Tariffs Mask Falling Inflation: Fed Policy Implications Analysis

This analysis is based on the Forbes report [1] published on November 13, 2025, which examines research from Harvard Business School’s Pricing Lab on how tariffs are masking underlying inflation trends.

Harvard Business School researchers Alberto Cavallo, Paola Llamas, and Franco Vazquez have developed a methodology using high-frequency pricing data from major U.S. retailers to track tariff pass-through effects [1]. Their key finding is that tariffs are adding approximately 0.7 percentage points to the Consumer Price Index, suggesting that without tariff effects, underlying inflation would be around 2.2% instead of the reported 2.9% in August 2025 [1].

The analysis occurs against a backdrop of mixed market performance, with major indices showing modest gains over the past 30 days: S&P 500 (+1.78%), NASDAQ (+2.27%), Dow Jones (+3.91%), while Russell 2000 remained essentially flat (+0.07%) [0]. The Federal Reserve has recently adjusted policy, with the federal funds rate at 3.87% following rate cuts that brought the target range to 3.75%-4.00% as of October 2025 [2].

The research reveals that current tariff pass-through to consumers averages 20% of the tariff amount, but the authors project this could increase to 100% within a few years [1]. This gradual pass-through creates a complex monetary policy challenge, as the full inflationary impact of tariffs may unfold over an extended period, potentially complicating the Fed’s ability to “see through” temporary effects.

The Federal Reserve faces a critical choice between three approaches [1]:

1. Full “See-Through” Policy
   : Easing rates based on underlying inflation near target
2. Cautious Approach
   : Maintaining higher rates due to tariff persistence uncertainty
3. Traditional Response
   : Tightening to bring total inflation to target regardless of source

Fed Chair Powell has previously referenced analysis suggesting that “seeing through” tariffs represents the better approach under certain assumptions, indicating this framework remains relevant to current policy deliberations [1].

A significant complicating factor is the ongoing government shutdown impact on economic data collection. White House officials have indicated that October CPI and jobs data may never be released, potentially leaving policymakers “flying blind” [3]. This data vacuum makes accurate inflation assessment particularly challenging when trying to distinguish between temporary tariff effects and underlying price trends.

Current sector performance shows divergence, with Communication Services leading (+1.38%) while Energy (-1.21%) and Technology (-0.81%) lag [0]. The tariff effects likely impact sectors differently, with import-heavy industries facing more significant cost pressures that could distort sector-specific inflation measurements.

1. Inflation Expectations Risk
   : If consumers and businesses begin to view tariff-induced inflation as permanent rather than temporary, it could necessitate more aggressive monetary tightening despite underlying conditions being near target [1].

2. Escalating Pass-Through Risk
   : The projected increase in tariff pass-through from current 20% levels to 100% over time could amplify inflationary pressure significantly, potentially forcing policy reversals [1].

3. Data Reliability Risk
   : Ongoing government data collection challenges impair the Fed’s ability to accurately assess economic conditions, increasing the likelihood of policy errors [3].

1. Policy Flexibility
   : If the research accurately reflects underlying inflation trends, the Fed may have more room for rate cuts than current headline CPI suggests, potentially supporting economic growth.

2. Alternative Data Value
   : With government data compromised, private-sector metrics and high-frequency pricing data become more valuable for economic assessment.

3. Sector-Specific Opportunities
   : Companies in sectors less exposed to tariff impacts may benefit from relative cost advantages.

The Harvard research suggests that headline CPI of 2.9% (August 2025) masks underlying inflation of approximately 2.2% when tariff effects are excluded, which would be at or near the Fed’s 2% target [1]. Current PCE inflation stands at 2.71% (October 2025) [2]. The Federal Reserve has previously analyzed alternative policy responses to tariff-induced inflation, with research suggesting that “seeing through” tariffs to focus on underlying inflation represents the optimal approach under certain assumptions [1].

However, significant methodological challenges remain, as the authors acknowledge assumptions that may prove inaccurate [1]. The gradual nature of tariff pass-through, combined with current data reliability issues from government shutdowns, creates an environment of heightened uncertainty for monetary policymakers [1, 3].

Business leaders should monitor tariff policy developments, consumer expectation surveys, and sector-specific cost pressures, as these factors will likely influence Fed policy decisions and market conditions in the coming months.