The US economy is on a collision course with inflationary stagnation, as economists warn of a perfect storm of high inflation and low growth fueled by ongoing trade tensions.
The Stagflation Scare: A Growing Concern on Wall Street
Economists and policymakers are growing increasingly concerned about the prospect of stagflation, a dreaded combination of high inflation and low growth. ‘We’re moving in that direction,’ said Jason Furman, a Harvard economist who served as chair of the Council of Economic Advisors under former President Barack Obama.
Stagflation is a rare economic phenomenon where there is a combination of high 'inflation' and stagnant economic growth, often accompanied by rising unemployment.
This occurs when an economy experiences both inflationary pressures and recession-like conditions simultaneously.
The term was first coined in the 1960s to describe the UK's economic situation.
Stagflation can be caused by supply shocks, such as oil price increases or natural disasters, or by monetary policy mistakes.
It poses significant challenges for policymakers, who must balance competing goals of controlling 'inflation' and stimulating growth.
The Perfect Storm: Tariffs and Trade
The ongoing trade tensions, fueled by tariffs imposed by President Trump, are creating a perfect storm for the economy. Imports and exports account for roughly a quarter of the US’s economic output, making them particularly vulnerable to disruptions. A full-blown trade war could reduce the volume of goods going in and out of the US, significantly hampering GDP.
Tariffs are taxes imposed on imported goods by a country's government.
They can range from a few percent to several hundred percent of the product's value.
The primary purpose of tariffs is to protect domestic industries and generate revenue for the World Trade Organization (WTO).
However, they can also increase prices for consumers and lead to trade disputes between countries.
According to the World Trade Organization (WTO), tariffs have been rising globally since 2016, with an average increase of 10%.
The Impact on Growth and Inflation
The International Monetary Fund had predicted that the US economy would grow 2.7 percent in 2025, the fastest among G7 nations. However, some economists have lowered their estimates to around 1.5 percent, citing the impact of tariffs targeting Canada, Mexico, and certain industries like automobiles. ‘We’re looking at a recession in mid-2025,’ said Diane Swonk, chief economist at KPMG.
A recession is a period of economic decline, typically defined as a decline in gross domestic product (GDP) for two or more consecutive quarters.
It can be caused by various factors, including inflation, high interest rates, and external trade disruptions.
During a recession, businesses may reduce production, leading to job losses and decreased consumer spending.
According to the National Bureau of Economic Research, the US experienced five recessions between 1970 and 2020, with an average duration of 11 months.
The Uncertainty Factor
A key distinction this time around is that Trump‘s tariffs are imposed through executive orders, making it difficult for foreign companies to decide whether they should move manufacturing to the US. This uncertainty creates a challenging environment for policymakers and businesses alike, as it makes it difficult to predict when or if tariffs will change.
The Federal Reserve in a Difficult Position
The Federal Reserve is facing a difficult position, with Fed Chair Jerome Powell warning that tariffs will cause higher inflation and slower growth. However, the central bank has not shared any plans for interest rate adjustments, leaving investors and policymakers waiting for clarity on next steps.
A Recession Looms?
Major banks are increasingly predicting a recession in the next 12 months. ‘We’re looking at a 45 percent likelihood of recession,’ said Goldman Sachs, while JPMorgan Chase estimates a 60 percent chance. The uncertainty surrounding tariffs and trade is creating a sense of unease among economists and policymakers, with some warning that the US may be heading towards a prolonged period of stagflation.
The Smoot-Hawley Legacy
The Smoot-Hawley Tariff Act of 1930 raised tariffs on 20,000 imported goods in an attempt to protect domestic industries during the Great Depression. However, those measures ended up worsening the economic crisis. Economists generally agree that today’s tariffs are a similar mistake, and that reversing them may be necessary to avoid a prolonged period of stagflation.
The Road Ahead
As the US economy navigates this uncertain landscape, policymakers will need to carefully consider the impact of their decisions on inflation and growth. With the Federal Reserve in a difficult position and major banks predicting a recession, it’s clear that the stakes are high.
