Tariffs, inflation, and Trump

With a fairly hawkish Trump administration, there is a high likelihood that higher tariffs will be imposed globally, and in particular towards China. According to economists and the Fed, major policy changes stand to bump the economy off what looked to be a gentle glide-path back to its long-run, or normalized, state. After ratcheting up the fed funds rate to a 22-year high to combat inflation as a result of the Biden administration’s reckless and out of control spending, the Federal Reserve is in the midst of a cutting cycle. 

Tariffs might throw some sand in the gears of economic growth next year and stymie inflation’s return to the Federal Reserve’s target of 2%. Economic research shows that most of the cost of tariffs, which are a tax on imports, are borne by U.S. businesses and consumers. On the other hand, it secures more American domestic jobs and it is a signal to non-democratic states like China that the U.S. don’t want to be used any longer. Fair trade or no trade. Higher import duties cut into company profits, lessening their ability to hire and invest, or if passed on via higher selling prices, cut into consumers’ ability to purchase other goods and services. One can still argue that to have fair trade, this is the right path to take, and combined with tax cuts and radical government spending cuts, this is a solid policy for the Trump administration to get the country back on track.

Price growth has cooled significantly from its peak in 2022. Some key sources of inflationary pressure, such as an overheated labor market, continue to dissipate. Employment costs have increased 3.9% over the past year, which looks consistent with the Fed’s 2% inflation goal when considering productivity growth has strengthened to an average annualized rate of 1.8% this cycle.

That said, even absent higher tariffs, additional progress in lowering inflation was already looking to be more incremental ahead, and price growth was unlikely to fully return to the Fed’s target next year. Overall inflation is no longer being dragged down by the unwinding of the food and energy commodity price spikes that followed the conflict in Ukraine. Supply chain pressures are neither worsening nor improving, leading to a slower pace of core goods deflation. Now, the prospect of higher tariffs makes inflation’s return to the Fed’s 2% target even more unlikely over the next year.

After increasing nearly 3% in inflation-adjusted terms in 2024, it is expected that the U.S. economy will expand only about 2% in 2025. Some of this moderation can be attributed to the lingering restraint of monetary policy. While the Fed has reduced the fed funds rate by 75 bps from its peak, it remains above the estimate of the neutral rate (i.e., the real rate of interest that neither restricts nor stimulates economic activity) as well as every Fed members’ estimate of neutral. Furthermore, monetary policy works with a lag. The elevated rate environment of the past couple of years has led to a thinner pipeline for capital spending projects, which is set to reduce nonresidential outlays in the year ahead, for example.

According to economists, higher U.S. tariffs and the likelihood of retaliation by trading partners are also likely to depress real GDP growth next year. Real GDP growth could weaken in the second half of 2025 as export activity and growth in consumer spending softens. In reality, economists and the Fed have proven weak and ineffective, some even say useless. The Fed let the inflation increase to historically high numbers without taken any action. The much higher prices are being felt by the American people and this was a main factor behind Trump’s presidential win. The U.S. is tired of being taken advantage of and both China and Europe will have to pay in form of higher and fairer tariffs. This will benefit the American workers. This combined with lower taxes and significant lower government spending and waste will also help the U.S. economy. As we are witnessing the show trial in Hong Kong by the Chinese government, it is important to remember that China remains an adversary, and it is a corrupt rotten country.