Could Donald Trump's tariffs cause a recession?

Gulf Today

18-03-2025

Sarah Foster,
Tribune News Service
Investors are growing increasingly concerned that President Donald Trump's tariff policies and federal layoffs could spark a US recession. An even bigger worry is that the Federal Reserve might not be able to do much about it. Officials on the Federal Open Market Committee (FOMC) are set to discuss at their March 18-19 rate-setting meeting what more can be done — if anything — to control inflation and rescue a slowing economy within an increasingly volatile economic and political environment. In a matter of weeks, Trump's post-election effect on the stock market has gone from 'bump' to 'slump.' Americans' investment accounts have been getting pummeled, with the S&P 500 dropping more than 8% from its all-time high on Feb. 19. The tech-focused Nasdaq Composite Index plunged 4% alone on March 10, its worst day of trading since 2022. A measure of volatility within financial markets, meanwhile, spiked to the highest since August, reflecting investors' struggles to parse through Trump's stop-and-go tariff hikes. To be sure, policymakers are almost certainly expected to leave borrowing costs alone this week. The Fed's chief central banker said as much in his final public comments before the committee's March meeting.
'Despite elevated levels of uncertainty, the US economy continues to be in a good place,' Fed Chair Jerome Powell said at an event hosted by the University of Chicago on March 7. 'We do not need to be in a hurry and are well positioned to wait for greater clarity.' Investors and consumers, though, will likely be looking for clues about what the FOMC expects to do the rest of the year. Along with its rate decision, the committee will also update its projections for economic growth, inflation, the job market and interest rates. The stakes couldn't be higher for an economy still battered by post-pandemic inflation. In addition to weighing on economic growth, tariffs could also push up prices at a time when price pressures remain elevated. In a Fox News interview earlier in March, Trump didn't deny that his policies could spark a recession and urged Americans to brace for a 'period of transition.' The Trump administration has also signaled that it may press ahead with new tariffs even if they weaken the economy.
What do threats of weaker growth and higher inflation mean for the Fed's next moves? Here are the biggest questions facing the US central bank as it decides what to do with the interest rates that influence how much you pay to borrow money. Save the economy from a slowdown or keep inflation in check? Fed officials could be forced to 'choose one over the other' Typically, higher prices and a slower economy are counterintuitive. Inflation usually indicates that the financial system is red-hot, a symptom of wage hikes or too much money chasing too few goods — similar to what happened during the pandemic. They also both require something different from the Fed. The US central bank slashes the price of borrowing money when the financial system might be losing steam and raises interest rates when they want to cool the economy.
The rare combination, however, has happened before: in the 1970s and early '80s. Back then, prices soared almost twice as high as they did during the post-pandemic era, while the Fed intentionally inflicted a devastating US recession — at the time, the worst since the Great Depression — to bring price pressures back down. Economists have a term for it that's become a dirty word for the Americans who lived through it: stagflation. 'The combination of policies that we are seeing right now has a real risk of bringing that on,' says Erica Groshen, senior economic adviser at the Cornell University School of Industrial and Labor Relations, who was the former commissioner of the US Bureau of Labor Statistics and vice president of research at the Federal Reserve Bank of New York. Even St. Louis Fed President Alberto Musalem, who has a vote on interest rates this year, said in public remarks on Feb. 20 that a scenario where inflation rises at the same time the labour market weakens 'must also be considered.' In those circumstances, the Fed's choices — rescuing the labor market or focusing on inflation — aren't easy.
Even as forecasts suggest Trump's tariffs could lift prices, though, investors have upped their projections for rate cuts this year. They're currently expecting that the U.S. central bank will reduce borrowing costs by three-quarters of a percentage point in 2025, moves that would bring the Fed's key borrowing benchmark to 3.5%-3.75%, according to CME Group's FedWatch tool. The 30-year fixed mortgage rate has already plummeted as Treasury yields reflect the possibility of lower rates, according to Bankrate's weekly survey of interest rates.
Tariffs could weigh on economic growth because they often lead to supply shortages, as companies attempt to reroute their supply changes. They also make production more expensive, weakening company profitability.
Case in point: The Fed reduced borrowing costs three times in 2019, in part because Trump's smaller-scale, first-term trade war injected a new layer of uncertainty about the pace of future economic growth. Even if Trump stands down on some of his toughest tariff hikes, some damage might already be done, according to Mike Skordeles, head of U.S. economics at Truist. Unsure of what the future may hold, Skordeles' business contacts have been telling him that they're hesitant to make new investments or hire more workers right now. 'When they don't know from day to day whether this tariff is being delayed or that one is definitely going to happen, tomorrow it gets delayed again, it causes a lot of uncertainty, much like for the Fed,' Skordeles says. 'Businesses say, 'I might as well sit and wait.' Sitting and waiting is not pro-growth.'
One indication of extra uncertainty: Businesses stockpiling on imports to get ahead of tariffs caused a key model predicting economic growth from the Federal Reserve Bank of Atlanta to plunge in late February. Another reason to err on the side of rescuing the economy, federal layoffs — which hit almost 63,000 last month, according to the latest data from Challenger, Gray & Christmas — could lead to job losses in the private sector, Groshen says. That could also weigh on consumer spending, keeping downward pressure on inflation, too. 'It can affect whole neighborhoods where you have concentrations of government workers,' Groshen says. 'Some of the laid-off people are going to find other jobs quickly and others won't.'
Typically, economists say tariff hikes are a one-time price increase — not an inflationary spiral. Trump's 25% tariffs on goods from Canada and Mexico, as well as 20% tariffs on goods from China, could increase price levels by 1%-1.2%, translating to an average cost per household of $1,600 and $2,000, according to the Yale Budget Lab's latest estimates. 'A tariff-induced bump in inflation, which is at the root of the concern for consumers and businesses, isn't by itself going to produce the type of trend that the Fed is most concerned about,' McBride says. 'It probably does more to slow growth than it does to contribute to persistent acceleration of inflation pressures.'
Even so, Fed officials might find it troubling if tariffs become ingrained in the psychology of investors and everyday people. Guided by their experiences in the '70s and '80s, Fed Chair Jerome Powell & Co. subscribe to an economic theory that expectations of sharper inflation can often become a self-fulfilling prophecy.