Trump, Tariffs, and the Fed: Is the Fed An Enabler?

One hears a criticism of Fed policy: By easing, the Fed is enabling Trump to pursue his strategy of raising tariffs to pressure countries to make trade deals favorable to the U.S. without suffering the full deleterious effect on the U.S. economy that would otherwise follow. But this is a critique that is political, rather than about monetary policy. 

It’s true that if the Fed does not offset the effects of policies that weaken the economy, economic performance will be worse. The consequence of that would likely be a lower probability of Trump being reelected. 

And on the other hand, doing so allows Trump to carry out policies he believes have benefits without as much accompanying damage to the economy. In this case, that set of policies might well contribute to his reelection. 

But look at it from the Fed’s perspective: It sees itself as a central bank with a duty to pursue full employment and 2% inflation, its interpretation of its mandate established by Congress. An independent central bank does not carry out the policy to influence the electoral process. 

If the economy slows or is expected to slow—for whatever reason—the Fed acts to offset it. Newtonian monetary policy, as I like to call it. For every action, there is an equal and opposite reaction. Concerning tariffs, the Fed’s reaction is to lean against the effect on aggregate demand. 

The case of tariffs is somewhat more nuanced because tariffs also raise the price of goods for consumers,  and therefore boost inflation. That might, at first glance, seem to call for a more restrictive policy. So does the  Fed act to offset the effect on growth or inflation? An easy choice. The effect on inflation is appropriately viewed as a temporary burst of inflation associated with the tariffs and a one-time increase in the price level— 

and not an increase in underlying inflation that the Fed would worry about. In contrast, higher tariffs are a  “real” problem for households because higher prices for imported goods will lower real wages—in addition to other effects such as deteriorating business sentiment and disruption to supply chains. That is why tariffs slow aggregate demand, production, and employment. The Fed should, therefore—and generally does—“look through” the temporary effect on inflation while responding to the effect on aggregate demand, which will not dissipate. 

So yes, Fed policy in a sense enables Trump to act on his penchant for tariffs. That’s a direction he believes will, in the end, result in lower tariffs. Maybe. But the Fed worries about the here-and-now, the reality, and not such hopes. The solution is not the Fed, but the ballot box. Voters will either approve or disapprove. It is the election results—not the Fed—that will either enable Trump or reject Trump.  

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