Trump's imposed tariffs might lead to a direst economic predicament akin to the 1970s, depicting a grim economic situation.
I examine the extent of financial and monetary stimulus that has occurred over the past five years – it's been quite astounding; how can you claim it won't result in stagflation? questioned Dimon during a conference in May.
This forecast, however, has been met with skepticism by many leading economic voices. Leading this criticism was Federal Reserve Chair Jerome Powell, who dismissed the idea at a press conference in May, stating, "I couldn't identify the stag or the 'flation."
This was before the election of Donald Trump. Now, Americans might need to prepare for stagflation – an economic phenomenon that the nation's economy has not experienced in more than half a century. This time around, though, the catalyst will likely be tariffs.
Within a month, Trump will have the authority to impose tariffs on other nations with a simple stroke of a pen. Upon assuming office on January 20, he has pledged to immediately impose a 25% tariff on Mexican and Canadian imports and increase tariffs on Chinese goods by an additional 10%.
During his campaign, he also vowed to levy a 10% to 20% tax on all imports and boost tariffs on Chinese goods by at least 60%.
There are questions about whether Trump will follow through on these plans, possibly using them as bargaining chips in negotiations with other nations. However, if these widespread and extensive tariffs come into effect, it could lead the US economy back to one of its most challenging periods, which took over a decade to recover from.
The US economy is currently far from stagflation
"I lived through stagflation. It was 10% unemployment. It was high single-digit inflation and extremely slow growth," Powell stated back in May, reflecting on the era when oil prices surged during the Arab oil embargo in the 1970s.
When the Fed intervened to address high unemployment levels in the 1970s by lowering interest rates to ease pressure on businesses, it subsequently had to grapple with higher inflation. To contain higher inflation, central bankers raised interest rates. However, this led to increased unemployment.
To break this vicious cycle, the Fed decided to prioritize curbing inflation aggressively, even if it meant inducing a recession. This strategy succeeded in bringing inflation down, but at the expense of the economy entering a recession.
The US economy isn't anywhere near the conditions the Fed faced throughout the 1970s and 1980s. The nation's unemployment rate, now at 4.2%, has risen over the year but remains lower than the average seen over the last 50 years.
Meanwhile, inflation has significantly decreased over the past two years. Currently, it only slightly surpasses the Fed's 2% target – a challenge in reaching that exact level.
The economy expanded at an annualized rate of 2.8% in the last quarter, although this was a slightly slower pace than before. Despite the Fed increasing interest rates to a level not seen in over two decades to combat inflation, which reached a 40-year high two years ago, the economy still managed to impress. The Fed started reducing rates earlier this year and is expected to continue doing so at its meeting this week. However, the effects may take years to manifest across the economy.
The path to stagflation
The tariffs proposed by Trump are not inherently inflationary, according to Michael Feroli, chief US economist at JPMorgan. Although they may cause many, if not most, goods purchased by Americans to become more expensive, this could be just a temporary increase in the cost of goods, similar to a sales tax increase. However, higher tariffs can rapidly escalate price increases if consumers expect higher inflation due to them and demand wage increases, resulting in businesses continually raising prices.
Applying new tariffs haphazardly and hastily, without giving businesses sufficient time to adapt, could potentially hinder economic growth by forcing businesses to cut back on investments due to heightened uncertainty.
Stagflation may also develop if other nations respond with counteractive tariffs on US goods, leading to job losses among employers.
Feroli believes the likelihood of the US economy experiencing stagflation is higher now compared to earlier this year. However, it's not the most probable forecast for his team of economists. They do not forecast inflation surging more than a few tenths of a percentage point above current levels, in part due to their belief that the Trump administration will allow US businesses ample time to adjust to higher tariffs if they are implemented.
Wells Fargo economists share a similar perspective.
"These tariff increases, if implemented shortly after the inauguration, would impose a moderate stagflationary shock to the US economy, lifting our inflation projections in the near term, but also dampening our GDP growth outlook," they stated in a note published shortly after the election. "If this occurs, the probability of a stagflation scenario in our growth model would likely increase."
"That said, there is much uncertainty regarding future potential policies," they cautioned.
Despite the current low unemployment rate and decreased inflation, the proposed tariffs by Trump could potentially lead the US economy back to a challenging period similar to stagflation. The authorities need to carefully consider the potential impact of these tariffs on businesses and consumers.
If the tariffs are imposed on a wide scale and businesses are not given enough time to adjust, it could hinder economic growth and possibly push the economy towards stagflation, a situation characterized by high unemployment and inflation.
