By Elisabeth Buchwald, CNN

New York (CNN) — Federal Reserve officials have worked hard to set interest rates at levels that minimize inflation and maximize employment over the past couple of years. And they’ve been remarkably successful, a historically rare feat to pull off.

But central bankers’ jobs could get a lot harder in just a matter of hours after President-elect Donald Trump takes the oath of office on Monday.

Some of his first orders of action, he’s said, will include ordering mass deportations of immigrants and enacting tariffs on America’s biggest trading partners. That could very well spur more inflation, some economists have predicted.

Or Trump could merely be using the threats as a negotiating tactic, essentially bluffing. No one really knows.

The heightened uncertainty “makes setting monetary policy much more difficult,” said Ellis Tallman, a former executive vice president and senior economic policy adviser at the Cleveland Fed.

Working around uncertainty

Hundreds of economists and researchers already help the Fed try to figure out how the many unknowns that could impact the economy will come together, creating so-called baseline forecasts that they can then tinker with as conditions change. They also run additional forecasts and simulations, or risk scenarios, that test events that could hurt the economy but are deemed less likely.

For instance, when Trump was elected in 2016, David Wilcox, then a director of the Fed’s research and statistics division, and his team, anticipated Trump would pursue tax cuts, a key campaign promise. Tax cuts tend to spur more spending from those who benefit from them. But Wilcox’s team didn’t know how the tax cuts would take shape.

His team started off assuming tax cuts would focus just on individuals. Later, as the legislative process moved along, they shifted to an assumption that the tax cut “would be much more focused on businesses,” said Wilcox, who advised Fed Chair Jerome Powell and other Fed officials. (He retired from the Fed in 2018 after 30 years at the central bank and is now an economist at the Peterson Institute for International Economics and Bloomberg Economics.)

“You need to be willing to change your mind when the facts on the ground change,” said Wilcox, referring to updating forecast models.

Powell, he noted, has been exceptional at navigating those situations and communicating with the public on what caused him to change his mind.

But scaling down the range of possibilities Trump may actually pursue is especially hard to pin down before his policies are officially announced — and that complicates producing forecasts that inform the policy path the Fed should set forth on.

Fed officials are divided on when to begin building new forecasting models

While the Fed can certainly update simulations like the ones produced in 2018 on tariffs, the policies Trump is proposing on tariffs and immigration now are so vastly different from those of his first term that they may not prove to be as useful.

In fact, existing models “aren’t really equipped to handle substantial changes in tariffs,” said Tallman. So officials have to decide when it makes sense to begin building new models.

“We’re going to get more tariffs, we’re going to get immigration controls and we’re going to get more of a deregulatory environment — all of those things are fairly certain,” Fed Governor Chris Waller said in an interview on CNBC last week. “What’s very hard to do is map that into forecasted numbers like inflation, unemployment (and) GDP growth.” From his current viewpoint, Waller said he doesn’t believe tariffs are “going to have a significant or persistent effect on inflation.”

For the time being, Atlanta Fed President Raphael Bostic said he’s reluctant to start building new models.

“I’m going to counsel my team to wait as long as possible” before making forecasts on how potentially higher tariffs could impact the economy, he told reporters on a call last month. “One of the things that we have seen over the last six or seven years is that there are lots of proposals that get floated around, and they change a lot as you go through.”

“Given that we have constrained resources, I want to make sure that we’re devoting most of our energy on things that have the highest likelihood of coming out,” said Bostic, who voted on interest rate decisions last year but won’t be this year.

St. Louis Fed President Alberto Musalem is taking an entirely different approach.

“We cannot wait until all that uncertainty is resolved” to make economic forecasts, he said last month in an interview with Bloomberg. “My staff is already doing exercises for different tariff configurations (and) how might that affect the economy,” he said.

A Fed in the limbo

For now, Chair Powell appears to be taking a wait-and-see approach.

“We don’t guess, we don’t speculate and we don’t assume,” Powell told reporters at a November 7 news conference, days after Trump’s victory, when he was asked how the Fed would respond to Trump’s economic proposals.

But at the same time, the Fed can’t afford to sit back entirely until there’s more certainty about Trump’s finalized economic policies because the interest rate decisions they make now can take years to be felt throughout the economy. That means that if they were to continue lowering interest rates, it could potentially add fuel to the fire, should Trump’s policies cause a resurgence in inflation.

The Fed’s dilemma over the uncertainty stemming from Trump’s second term was noted in a recently published summary of the Fed’s December 2024 meeting.

“Given the elevated uncertainty regarding specifics about the scope and timing of potential changes to trade, immigration, fiscal, and regulatory policies and their potential effects on the economy, the staff highlighted the difficulty of selecting and assessing the importance of such factors for the baseline projection and featured a number of alternative scenarios,” the summary stated.

In addition to at least a 20% across-the-board tariff on Canadian and Mexican goods and a 60% levy on Chinese goods, Trump has vowed to implement a 10% tariff on all imports. He also said he would require countries that are part of BRICS — a China- and Russia-backed group of emerging economies — to commit to not creating new currency or face 100% tariffs during his administration.

It remains unclear if or when he would sign such tariffs into law and whether certain goods would be excluded. But a complicating factor for Fed forecasters and officials is that Trump can move forward with new tariffs without congressional approval, leading to potentially radical changes virtually overnight.

Still, even once there is more certainty on what Trump will do with tariffs, “their impact on the economy is unclear,” said Steven Kamin, a senior fellow at the American Enterprise Institute and former director of the International Finance Division at the Fed. “In situations like these, it’s premature to actually act, but you do need to prepare.”

Cleveland Fed President Beth Hammack said that if tariffs on different products or countries take effect at different times, “It may make it harder for us to say, ‘Are we able to look through some of these?’” she told the Wall Street Journal in an interview published Friday. “Some of the signals on inflation are going to be harder to read.”

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