Introduction
Distinguishing between “risk,” “uncertainty,” and “radical uncertainty” is crucial for both economic theory and its implications for markets, policy, and financial stability. Over the past century, economists have debated these concepts, with differing schools of thought offering contrasting views on how markets and policy should respond to each. Recently, these concepts have become essential to understand how tariff shocks may impact the global economy and financial markets. They are also critical for and understanding of the Federal Reserve’s recent policy guidance.
We argue that the current policy environment is assessed by financial markets as one of “risk,” but it could easily shift into a much more damaging environment of “uncertainty” or even “radical uncertainty” if President Trump’s tariff agenda further disrupts the global economic order. Although they use different terminology, the Federal Reserve also appears to be thinking in terms of “risks” rather than “uncertainty,” with a central scenario of proceeding with dovish caution. However, a shift toward a more “uncertain” world could prompt Powell’s Fed to adopt a more aggressively dovish stance, particularly if inflation expectations remain anchored and it becomes clear that the adverse impact on output outweighs the impact on prices.
In recent days, market expectations seem to have been shifting markedly in this direction as they await “Liberation Day” on 2 April, 2025.
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