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If you just look at the basic data and don't look at the forecast, you would say that we would have continued cutting.

The difference, of course, is at this time all forecasters are expecting pretty soon that some significant inflation will show up from tariffs, and you know, we can't just ignore that.

I'm Stephanie Flanders, head of Government and Economics at Bloomberg, and welcome to Trumpanomics, the podcast that looks at the economic world of Donald Trump, how he's already shaped the global economy and what on earth is going to happen next.

And this week we're digging into whether the Federal Reserve has been wrong in its assumptions about the economic impact of Donald Trump's tariffs.

The entire White House wants Federal Reserve Chair Jpowe to lower interest rates.

Commerce Secretary Howard Luttner slammed him, saying he's afraid of his own shadow for keeping interest rates so high.

Treasury Sectory Scott Besant has also repeatedly pointed to the markets here, arguing that they've sent a clear signal that a cut is overdue.

And of course we've heard the President himself nickname the FED Chair many times too late, Powell calling it a fool not a smart person for his refusal to cut rates.

So we're asking a simple question.

Do they all have a point?

I mean, maybe not about the J.

Powell being smart part, but have Chairman Powell and the Fed's Interest Rates Setting Committee, the FMC been too slow to cut rates?

And the answer to that, it turns out, depends on whether they're correctly judging the likely impact of the President's tariffs on inflation.

Because, by his own admission earlier in the year, Chair Powell was expecting to have lowered interest rates by now, and the main reason that changed was the so called Liberation Day when President Trump unveiled his sweeping new time tariff policy.

At that point, Powell and nearly all of his FED colleagues decided to air on the side of caution, waiting to see if the trade conflicts and tariffs increased inflation in the US.

But were they wrong then and are they wrong today?

Well, we have two excellent guests to discuss that.

First, we've invited back Orn Cass to Trump Andomics.

He's the founder and chief economist of American Compass, author of the once and Future Worker, a vision for the renewal of work in America.

He's also served as a domestic policy director for Governor Mitt Romney's twenty twelve presidential campaign, and has been a senior fellow at the Manhattan Institute for many years.

Auran, I'm really glad to have you back on Trump andomics.

Oh, thank you that this is such a fascinating topic.

I'm excited to dig in.

That's a very good start.

And back again we have Anna Wong, chief US economist for Bloomberg Economics, and before that she worked at the FED, US Treasury and White House Council of Economic Advisors during Donald Trump's first term.

Ann A, great to.

Have you back.

Happy to be eat back, so lurin.

There's so many things I could talk to you about.

You're relatively distinctive in the currency of commentary on the administration, in being both supportive of the president's basic agenda but very rigorous in thinking about the best way to make it a reality.

And you certainly don't follow the president slavishly.

But one column you wrote I did want to talk to you about you were really agreeing with Donald Trump in suggesting that the FED had just got the impact of tariff's on inflation completely wrong.

So talk us through the reason you think the FED has been wrong to talk about and indeed lots of economists to talk about tariffs being inflationary.

Well, I think the interesting thing that I've discovered, as I can get more involved in this fight, is that economists, actually, for the most part, if pressed on this question, will admit that tariffs are not inflationary.

The definition of inflation, certainly as it is relevant to a central bank setting monetary party, concerns an ongoing increase in the overall price level.

If you choose a specific policy that by design makes a one time change in the price of certain things, that is not inflation in a sense that you would want a central bank to worry about, or that you would ever try to address by raising interest rate or keeping interest rates higher.

As far as I can tell, you know, when economists are pushed beyond their talking points of just hating tariffs and wanting to attack them anyway they can, they will admit this is not what inflation means in the way that economists are talking about it for purposes of monetary policy.

And so look, if the FED wants to say, given current economic conditions.

Broadly, we think rates are at the current level.

They could say that the problem is that you have J.

Powell out there explicitly saying, I would say we should be cutting except for the fact that we expect for inflation from tariffs.

That simply an indefensible position to be adopting.

Why do you think economists have been so quick to talk about tariffs as inflationary.

Well, because I think economists, and again not hashtag not all economists, but most economists have shown over the last couple of years to have a very deep ideological opposition to tariffs that has quite toxically interfered with their ability to engage in public debates on the issue.

I think there are all sorts of perfectly valid criticisms to make of tariffs, but economists are determined it seems to win the political fight over them.

And over the last few years, obviously, inflation has become a very salient political concern, and so you could see, you know, as Trump was gaining steam last year, you just saw them start to jump up and lob this talking point in even though you could even go back to Trump's first term and look at not to the same scale as what's going on right now, but Trump imposed very significant tariffs, particularly on China.

It's very hard to find back then.

A lot of people focusing on inflation related critiques.

It's also very hard to find any inflation in the data from that period.

But this became a political point to score, and I think unfortunately a lot of economists have decided that the ends justify the needs.

So just to be clear, you think that prices will go up or the price level will go up in response to the tariffs, but nothing else will happen after that, and there won't be any kind of increase in wages as people try and sort of catch up with the high cost of living represented by that high price level, or anything else that could be inflationary.

Well, I would love to see an increase of wages because we see investments in that lead to rising productivity.

But with respect to other macroeconomic effects like you just mentioned, you know, I really do think the right way to analyze tariffs is the way that we analyze other taxes.

If somebody proposed the addition of a VAT, economists would not warn that it is inflationary.

If anything, they would say it's probably deflationary because we would potentially be raising additional revenue and that could go towards addressing the deficeit.

I think another very good example is carbon taxes.

Without saying any but the merits of carbon taxes, it's safe to say that the many economists that aggressively support carbon taxes as efficient and the ultimate in wise neoliberal policy do not spend a lot of time worrying that that is going to set off some sort of inflationary spiral.

What you are getting is a change in relative prices.

Of course, you also have the problem that economists are talking out of both sides of their mouth, because what they really say is that they think tariffs are going to slow the economy down.

If they actually took seriously their own view of the effects that tariffs would have, should probably lean toward looser monetary policy.

If anything, this is not an argument about the independence of the FED.

This is not an argument that prices are not going to rise in some cases that consumers are going to feel the effects.

That all is true, and in fact, that is the point of tariffs.

But if what you're asking is how a central bank and how monetary policy should address them, it seems to have gotten very unproductively entangled in a lot of this political rhetoric as opposed to what it is that economists themselves are otherwise arguing in almost every case.

Now, Anna, I know there's lots of different pieces of this, so we'll try and sort of unpack different elements.

But as our chief you, as economists, you're obviously trying, as far as any of us is humanly able, to strip ideological concerns and politics out of your analysis.

You're mainly looking day to day at what you're actually seeing in the economy and then thinking how that feeds through into your full cast and your analysis.

But if you're stepping back from all of that, a few months ago, would you have said these tarerts are going to be inflationary?

Yeah, a few months ago I had penciled in a point three percentage point increase in the core PC from all the tariffs, and I still maintained that forecast, And I also had written a lot about how I think there's a big chunk of the tariffs that would be absorbed through profit margin and that services this inflation can offset some of them.

Given that US at the end of the day is a service oriented economy.

And so what is your response to to Ooren's argument, do you think the FED has overdone the risk of inflation from these tariffs, because of course we would expect a short term increase in prices without necessarily thinking that this is an inflation problem that the central bank needs to respond to.

Right.

The reason why I had that view a couple months ago that there's a possibility that the tariffs would not be as inflationary is because of fed's own internal models back in twenty eighteen.

So, back in twenty eighteen, in one of the FOMC meeting, FED staff were studying why aren't tariffs as inflationary as they had forecasted.

The first round of Trump tariffs?

Yes, and they ran two models.

This is a very well established internal general equal over model, and one of them shows that if tariffs were imposed in primarily intermediate goods, which it was back in twenty eighteen twenty nineteen, then the inflation would be very short lived and even deflationary after the first couple of quarters.

And then another version of the models, as supposed that all the tariffs were on consumption, what happens?

It also shows that the tariffs would be a one off price level shock.

In fact, the FED even ransom versions of the optimal monetary policy of whether to look through this tariff shock versus not looking through, and the model would find that raising rates in respond to the price increase would not actually reduce inflation any further from the tariff.

So the conclusion is that if inflation expectations are anchored, there is no point in responding to the tariffs.

So what's changed in this round in trade war?

Number two in the FED thinking and respond to tariffs, from my observation is number one, they seem to be not so sure whether that inflation expectations are anchored, so that is the precondition of monetary policy not looking through these tariff shocks.

And second, they seem to be really embracing a new trade literature that use a new type of trade models, and those trade models would come to different conclusions than the models that the FED used in twenty eighteen.

And the new conclusion is that in fact, tariffs on intermediate goods would be persistently inflationary due to the impact on productivity.

So from where I see it, those two are the key differences intellectual key differences for why the FED is responding differently than from the lesson they learned in twenty eighteen and twenty nineteen.

That's an interesting comparison.

The importance for the judgment called by the central bank of whether or not they view inflation expectations to be well anchored.

Is there a risk, because people are already worried about inflation, that this so called one off increase in prices will actually cause people to demand catch up wages and then sort of spiral after that and it will become inflationary.

Or are they pretty confident going into it that this is just a one off that inflation's going to stay low, in which case you probably don't want to do anything.

And you had an example, I think in Japan when they increased VAT, the central bank didn't do anything, allowed the inflation to effect to come in, and then inflation fell back down and there was no issue with how the central bank had left it because expectations were well anchored, Whereas in Turkey, where there was a lot more question mark around the independence of the central bank and the likelihood of further inflation, they had increased taxes VAT through the two thousands, and that had actually helped to further un anchor inflation expectations.

The sort of pre existing situation in terms of what people are expecting about inflation matters, And I guess coming back to you are and I mean, is it your view that there was no risk of that kind because inflation expectations coming in this period were basically well anchored.

If you are wondering how consumers feel about inflation, then of course what the Central pain does and says is quite endogenous to that question.

So what you can't have, and apparently we do now have, is a set of models that say tariffs are not inflationary, a set of economists to say, oh, but we really don't like tariffs, and therefore we are going to spend years running around shouting that tariffs are inflationary, even though we know that our own models say that they are not, until we persuade consumers that they will be inflationary, at which point we can say, you see now, they will be inflationary and use that as an excuse to impose a monetary policy directly counter to the political choices that people have made supporting an agenda that focuses heavily on accepting a change in the price level to induce higher levels of domestic investment.

And so this is where I just get so frustrated that the sorts of things that I'm talking about are pointed at.

It's like, oh, he doesn't respect central bank independence.

I would like nothing more than a competent, honest, independent roach to setting monetary policy, and that is not what we are getting right now.

If the FED had spent the last couple of years accurately communicating, if the economists had spent the last couple of years accurately communicating what their own view of terror effects on price levels would likely be, we could have this conversation.

I think it is.

It is very hard to stummach situation where they have created this consumer mentality that they now say that they need to counter with policies that their own models said they should not need to be using.

I like the way you describe it.

But one could also say that the FED itself had played a role in unanchoring inflation expectations.

You know, we highlighted some of the comments from the Lutnik, and the President himself at the beginning would say that the FED had got policy wrong in a very damaging way and had let inflation get out of control.

They would say for political reasons.

Presidence says it was because he was Ja Power's trying to get the Democrats re elected.

But putting that to one side, that a lot of people would say there had been a policy mistake which had then left a situation where there was a potential unanchoring of expectations that people had begun to expect inflation.

So I guess the critics can't have it both ways.

They can't say they caused a lot of damage by allowing inflation to stay as high as it was for as long as it was, but now they shouldn't be taking that into account and thinking through the long, longer term impact of tariffs.

Well, I guess I would look at that a little bit differently, which is that, Yes, I think it is very fair to say that the FED damaged its credibility by getting this wrong last time.

I do not think it helps the Fed's credibility that when one party's administration pursued one set of policies that, frankly, I think most economists would say are very inflationary, like dumping trillions of of additional spending into an arguably overheated economy in ways, you know, long after the economic effects of COVID past, when you look at that and say, well, you know, hey, maybe they let's let's hold off, and you get it completely wrong.

And then the other party comes in with a set of policies that, in fact your own models say are not inflationary, but there are policies you don't like.

You then take exactly the opposite stance again.

If we want to characterize the Federal as primarily to be the nation's psychologist and stick its finger in the wind, I guess it can justify anything it wants to do, but I think it is it is badly and frankly more so than Donald Trump, endangering its credibility as an independent institution if it takes what are clearly such nakedly political judgments in lieu of actually doing what I economic theory and common sense say would be good governance of monetary policy.

And you spent a formative part of your career as a FED economist, I suspect that you will be conflicted in answering this question.

But do you think that the FED has been coherent in its approach over the last couple of years, and particularly the arguments it's had with itself and made to the public over the last six months.

Over taris, Yes, definitely, I am conflicted because I think the truth is I think there's a difference between FED independence and FED accountability.

I wholeheartedly support FED independence, but on the accountability part, if a public institution demonstrates in the past five years that it had made so many policy mistakes and misjudged forecast, then it probably is not enough to say that, well, most of the economist professions says this, so we are not alone in making this mistake, and accountability begins with looking deep into the institution to figure out why is it that the FED, with all this very smart economists, and I have to say FED economists are the smartest people I've met, why do they persistently take the sides on these economic issues that turned out to be wrong?

And so to Ourn's point, I would look at this not as you know, the FED policy mistakes driven by FED economists actively being political to thwart President Trump's agenda, but more like it is a bigger issue of group think in the economic profession, for example, thinking why in twenty twenty one that their focus is on labor scarring when you know, the thirty people CEA in the administration already had calculated that the extended unemployment insurance will more than cover income for half of the population, and therefore people would be not motivated to work.

So there were sort of intellectual biases rather than political bias.

You would yes, you're going on that assumption.

Just to jump in briefly, the idea that intellectual biases and political biases are separate, I think fair enough.

Fair enough, I will.

Take Anna's acknowledgment of intellectual bias as in fact an acknowledgment of political.

Okay, But the example there was what you might call in retrospect and excessive focus and excessive concern for labor market scarring.

But I think economists on all sides would be concerned about labor market scarring, you know, long term impacts of COVID for the labor market.

No, I completely agree that that labor market scarring is is an important issue.

I would just say also that reindustrialization is an important issue.

And so in the moment where you have an administration with a I would say quite robustly politically ratified strategy of intentionally raising prices on imports making a price level change on imports in an effort to induce high levels of domestic investment, which, by the way, would would directly indicate and benefit from lower interest rates.

To take that sort of set of priorities and curR concerns and say no, no, that, you know, we must stay laser focused on on well, frankly, it's not clear to me what the focused on at this point.

Whereas when we have a democratic administration saying, oh, we need to we need to dump trillions of dollars of stimulus into the economy as a way of addressing a set of concerns, and weould say, oh, well, let's we better give them the benefit of the doubt and let them run with that.

That is hard to square.

Okay, so we've done a lot.

We've sort of done a little bit of climbing in the brain of the bed as far as we can and thinking about whether or not it made sense to have the judgments that they've had.

But I mean, some people listening would say, hang on a minute, can't we just ask anna what's actually happening in the economy.

I know it's early days, but are we getting a sense of who's right and who's wrong.

Our team come at this from both a theoretical and empirical and data science perspective.

So in terms of just looking at the type of prices that we have been seeing increase in the past three months since Liberation Day, so we have seen that of each one percentage point shock to tariffs, we have estimated approximately zero point three percentage passed through to consumer prices, and most of this is concentrated in these discretionary consumer goods like household appliances, audio equipments and such, and they make up about less than ten percent of the CPI.

On the other hand, the consumer sentiments shock from Liberation Day, what it did is immediately dampen services spending and also discretionary stuff such as travel and hotels.

So we have seen both air fears and hotels more than offset the tariff passed through so far.

So on net, the CPI has still been very subdued in the past four months.

For that reason, and looking forward to the next couple of months and next week in the FMC meeting, the FED is most likely to hold raised constant even with two possible descent from FED governors Bob Waller and Bowen, and the reasoning for holding raids constant is that they expect that with infant horries to sales, the stockpiled inventories running out in July and August, firms will have to restock at higher prices, and therefore that the long forecasted inflation search will come after July.

So I think to settle the argument of whether tariffs are inflationary or not, really, the key data points will happen over the next two months.

As you say, at the very least, it seems like they are airing on the side of caution, and they've almost made a virtue of that in the comment.

I mean, do you think Anna that they should just cut rates next week and not be so cautious because they could always obviously increase interest rates if they got it wrong.

So I'm arriving at a similar conclusion as Orrent, but not for the exact reason, which is that I think that the FED is, you know, being somewhat internally inconsistent for saying that inflation expectations are very well anchored.

If they really were, then they wouldn't be so worried about the long term effects.

Yeah, exactly.

So one thing has to be wrong, which is inflation expectation really not anchored that well.

Or is it that inflation are anchored well, but then they are expecting something that is outside of what their models would tell them.

And I would take the side that I think, in fact, inflation expectations are not very well anchored.

So the part where I'm agreeing with Oren is that maybe the FED had made several policy mistakes the last four years, perhaps by caring too much about soft landing and therefore not returning inflation expeditiously to two percent and leaving a situation today where you have a terror shock that should be just a price level impact, should just induce a price level impact.

But because of those not very well anchored inflation expectations, they couldn't cut.

Okay, we get to the end.

Orn You've reminded us a couple of times in this conversation that there is actually a point behind higher tariffs, and certainly from your perspective and the perspective of all those who who see this as part of a reindustrialization of America agenda.

So I feel like we should at least end by asking you how you think that's going.

You know, the way that the tariff's deals are working out.

You know, we've now had a few from quite a lot of the sort of East Asian high exporting economies have now appeared to have struct deals with the administration.

Do you think that the kind of level of tariffs that are coming out of those deals, maybe fifteen twenty percent for most goods, you know, is consistent with a decent chunk of production coming back to the US.

Yeah, I think it certainly is.

I think we are very early days, obviously in a process where the first step is inducing investment, and so you know, the the gains that we should expect to see are things that are going to come out over the next few years.

You Know, what I think is most encouraging is that raising a sort of baseline across the board tariff, having much higher tariffs on China.

Both of those things I think are increasingly kind of priced in, so to speak, as the new status quo.

And contrary to virtually every economists predictions, those those things appear to be things that you can in fact put into place without the world coming to an end.

And so I think that's a very good start.

I think with these country by country negotiations, you know, we're starting to see these deals emerge.

I think even those have proved not especially stable thus far, and so it's going to take some time to see what has actually been agreed to and what's going into effect.

As you mentioned it at the outset, I have no shortage of complaints at the tactical level with how things are going.

I think, you know, stability and certainty is vital to this sort of project working, and we need a lot more of that.

But I think the extent to which everything that we were told was going to go horribly wrong has not, and things we were told could not possibly happen in fact are starting to happen.

I think that is all cause for cause, cause for optimism.

This is not going to end though, right because I mean, another thing that's happened that was supposed to be much harder than it appears to have been, which is the closing of the border means potentially of quite a dramatic reduction in labor force growth this year for the US, and that also is something that could push up wages along with this sort of increase in import prices.

You know, you've said, you know that you'd like to see that as a step towards the sort of re endotualization.

It's a natural part of that reindustrialization process in the US.

But it'll trigger all the same kind of debates about inflation, right, it will.

And it will trigger all the same humiliating hypocrisy from a profession that's spent the era of open borders telling us that this does not affect wages because of course the immigrants are consumers as well as producers, until the moment when inflation became a concern, and then they started arguing no, no, no, no, you need these high levels of immigration to expand labor supply, as if those people are not equally consumers and producers.

Look, I do think that restrict immigration would have a positive long run effect on wages.

I think that's a trade off, even if it comes with again changes in price levels that we should absolutely embrace.

But I have even less patients on this front than on the trade runt for the spine shattering whiplash of a switch from telling us that, of course, immigrants have balanced effect on both sides of the labor markets as consumers and producers, to telling us that if we pursue a policy that economists don't like, for ideological reasons it's going to have wildly imbalanced effects and so we can't do it well.

And if anyone wants to hear your views in greater depth on that subject, it was actually what we discussed when you came on the show at the beginning of the year.

But or in Cass, thank you so much for joining us.

I suspect if all the scary forecasts from the implications of Donald Trump's policies continue to not quite be born out, I suspect we will have you back again.

Thanks very much.

And if they are all born out, I'm happy.

To thank you very much, and thank you to Anna.

Thank you.

It's good to be here again, and thank you for listening to Trumponomics from Bloomberg.

It was hosted by me Stephanie Flanders, and I was joined by the economist Orn Cass and Bloomberg's chief US economist, Anna Wong.

Trumponomics is produced by Samasadi and Moses and Dam with help from Amy Keen.

Sound design is by Blake Maples and Sage Bowman is head of podcast for Bloomberg and please help everyone else find it and enjoy it, rate it and review it highly.

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