After the election, economists warn of fresh inflation risks
A rigorous 2½-year struggle to reduce inflation seems to be yielding positive results. The upcoming election has the potential to alter the current landscape. Inflation has declined, propelled by elevated interest rates, the recovery of supply chains, and an increase in the labor force. However, the trajectory of borrowing costs and price growth in the coming year may significantly depend on the policy decisions made by Donald Trump or Kamala Harris.
Both candidates advocate for growth-oriented policies that could prevent inflation from declining further. However, there are concerns among economists and even those with conservative leanings that the policies endorsed by Trump, in particular, may exacerbate inflationary pressures. These encompass his plans to impose universal tariffs on foreign imports, to expel laborers, and to pressure the Federal Reserve into reducing interest rates. “When considered collectively, these factors are increasingly contributing to inflationary pressures.” “I have genuine concerns regarding the potential escalation of inflation in 2025,” remarked Brian Riedl, a former aide to the Republican Senate, currently affiliated with the conservative Manhattan Institute.
Furthermore, a second term for Trump would occur within a markedly different economic context compared to his initial tenure, characterized by a prolonged period of low and stable price pressures. Recently, there has been an uptick in bond yields, driven by anticipations of a Trump victory in the presidential race, which could lead to increased deficits, inflation, or a combination of both. In light of the altered economic landscape and the expansive policies put forth by Trump, concerns arise that inflationary pressures could be exacerbated during a potential second term, according to Marc Short, who held the position of legislative-affairs director in the Trump administration. Trump’s proposals may lead him into fresh confrontations with the Federal Reserve, whose primary responsibility is to maintain low inflation levels.
Inflation is predominantly influenced by international dynamics rather than the actions of specific presidents. Throughout Trump’s presidency, the lingering effects of the 2008 global financial crisis maint ained a dampening effect on demand and price pressures worldwide. Inflation surged soon after President Biden assumed office, coinciding with the U.S. emergence from the pandemic. The robust demand stemming from the reopening was significantly enhanced by exceptionally low interest rates and the fiscal stimulus measures implemented by the Biden administration. All of this collided with disrupted supply chains and chaotic labor markets. In 2022, inflation surged to 9.1%, a consequence of the upheaval in global energy markets following Russia’s invasion of Ukraine. Inflation has declined consistently as supply issues have been resolved and the Federal Reserve has raised interest rates to avert additional overheating or asset bubbles. The consumer-price index decreased to 2.4% last month, nearing its pre-pandemic levels. In the foreseeable future, prevailing global trends are expected to remain the primary catalysts of inflation, while heads of state possess the capacity to either amplify or mitigate these influences.
Harris has committed to addressing the cost-of-living crisis through an increase in home construction, stringent measures against purported price gouging, and an expansion of tax credits for families with young children. She has pledged to balance any new expenditure initiatives with tax hikes or alternative revenue enhancements, yet has not suggested substantial direct deficit reduction measures. “Should the Democrats maintain their grip on power, I do not anticipate a significant surge in inflation; however, it is possible that inflation could persist in a somewhat sticky and obstinate manner,” remarked Riedl.
Trump aims to prolong certain elements of his 2017 tax-cut legislation set to lapse post-2025, alongside a proposal to reduce corporate tax rates further. He has additionally suggested the removal of taxes on gratuities received by workers, overtime compensation, and Social Security benefits for retirees. The alterations in trade and immigration policy, which grant the president greater latitude to operate independently of Congressional consent, render Trump a more unpredictable factor in the political landscape.
“Should he follow through on his stated intentions, it would undoubtedly result in a negative supply shock for the U.S. economy.” “Prices are set to rise, while the economy’s ability to provide goods and services is expected to diminish,” stated Adam Posen, president of the Peterson Institute for International Economics. A study by the Peterson Institute projected that the deportation of immigrants would markedly diminish economic output and simultaneously elevate inflation rates. As the labor pool diminishes, enterprises face a critical choice: either increase wages and prices or endure reduced profit margins.
Proponents of the Trump administration’s immigration initiatives argue that the economy stands to benefit if American workers receive higher wages for positions presently occupied by foreign laborers. “Should we indeed confine the labor market to American workers, their wages would increase, consequently leading to higher prices,” stated Oren Cass, founder of American Compass, a think tank aligned with Trump’s trade and immigration policies. “That appears to align with the fundamental principles of market operation.”
However, numerous experts caution that labor markets exhibit greater complexity and advise against overlooking the ripple effects associated with a diminishing workforce. Researchers from the University of Colorado, Denver, conducted an analysis of the deportations executed by the Bush and Obama administrations during the period from 2008 to 2014. Research indicates that for each million unauthorized workers removed from the United States, approximately 88,000 American jobs are lost. This is due to the fact that immigrant labor in specific sectors like food processing, agriculture, construction, and hospitality does not inherently compete with American workers. Should existing employees be removed, businesses may opt to reduce production levels instead of recruiting additional native-born workers. A decline in sales consequently results in a reduction of higher-paying employment opportunities for native-born workers within those sectors.
Consensus among business leaders and economists indicates that the financial burden of tariffs will ultimately fall on U.S. consumers. “We will pass those tariff costs back to the consumer,” stated Philip Daniele, chief executive of AutoZone, during an earnings call last month.
Trump has proposed a universal tariff of 10% alongside tariffs on Chinese imports reaching 60% or more. Both extend significantly beyond any of his prior endeavors. Trump’s advisers contend that his proposed tariffs would not lead to inflation. They argue this is supported by the relatively contained inflation during the more restricted tariffs imposed in 2018 and 2019, or they suggest that the mere threat of increased tariffs could serve as a strategic tool for negotiation. “Similar to 2016, financial markets and purported expert predictions suggested that Trump’s policies would lead to diminished growth and increased inflation…. “The actual growth and job gains significantly exceeded these assessments,” stated Brian Hughes, a senior campaign adviser.
Certain conservative economists argue that Trump’s commitments to deregulate, particularly within the energy sector, may alleviate inflation by eliminating obstacles to production. Short, who served as the former legislative-affairs director under Trump, remarked that the initial administration failed to deliver on its commitment to reduce spending. Similarly, he argues, investors are misjudging the potential risk that a subsequent administration may adopt a less business-friendly approach by attempting to select winners and losers. “The initial administration pursued a notably deregulatory agenda, and it remains uncertain whether a second term under Trump would replicate that approach, as many of the current advisors to the president appear to advocate for a more interventionist stance by the government in economic matters,” remarked Short.
For the Federal Reserve, assessing the downstream effects of elevated tariffs presents a complex and challenging task. Any resurgence of inflation may prompt authorities to reconsider or even suspend their intentions to lower interest rates. Last month, they initiated a reduction in rates that had reached a two-decade high. During his tenure, Trump consistently advocated for reduced interest rates and would have the opportunity to appoint a new chair of the Federal Reserve in 2026. Short anticipated a president who would engage extensively with the Federal Reserve. Federal Reserve officials may determine that tariffs resemble a tax increase that dampens demand. In 2019, elevated tariffs disrupted stock markets and posed a risk to business investment. The Federal Reserve reduced interest rates, determining that the adverse effects of the trade conflict on economic expansion would surpass any potential inflationary pressures.
There are those who contend that the central bank may adopt a stance of neutrality. During a conference this summer, Federal Reserve governor Christopher Waller, appointed by Trump, indicated that if tariffs lead to a one-time price increase, “it appears to be the quintessential supply shock that a central bank ought to simply disregard.” Concerns have emerged that tariffs may exacerbate inflationary pressures. Workers may begin to seek increased wages in response to rising prices. U.S. trading partners may respond by imposing tariffs on additional goods, potentially sparking a cascading trade conflict. “That, in my view, appears to be more inflationary rather than a singular adjustment in the price level,” remarked Chicago Fed President Austan Goolsbee during an interview this summer.
Furthermore, the Federal Reserve may face challenges in maintaining its current stance should inflationary pressures escalate, particularly given that officials previously misinterpreted the price surges of 2021 as merely “transitory.” As inflationary pressures became more widespread, the Federal Reserve responded with a series of aggressive rate hikes to prevent businesses and employees from adopting the expectation that elevated prices would become a permanent fixture. “Concerns are valid that a second wave of inflation occurring so soon after the initial episode will present significantly greater challenges,” stated Posen. The escalating budget deficits represent a significant cause for apprehension. Concerns are mounting among analysts that the expanding array of spending and tax-reduction commitments from both candidates may result in escalating deficits, as politicians could misjudge the true costs involved. Experts suggest that the nation would benefit from a reduction in budget deficits, allowing the central bank to lower interest rates even more.
The Committee for a Responsible Federal Budget, an organization focused on advocating for deficit reduction, projects that Harris would increase the deficit by approximately $3.5 trillion over the next ten years, whereas Trump would contribute an additional $7.5 trillion. The interplay of escalating deficits alongside inflationary immigration and tariff strategies under Trump poses a significant risk of triggering a chain reaction in the bond market, compelling investors to seek elevated yields to compensate for the increased risk associated with Treasury securities.
“Should he engage in confrontations with the Federal Reserve, and if nations begin to respond in kind, at what juncture do markets become genuinely unsettled?” stated Robert Zoellick, who previously served as president of the World Bank and held prominent positions in trade and the State Department under George W. Bush. “It may trigger significant economic upheavals.” Once these forces are set in motion, the potential for rapid and significant escalation becomes apparent.
Ohio Senator JD Vance, a potential running mate for Trump, expressed apprehension regarding the reactions of global bond investors to a prospective second term for Trump. “Are the bond markets and international investors attempting to undermine the Trump presidency by driving up bond rates?” In a recent interview, Vance articulated his views to conservative political commentator Tucker Carlson. He emphasized that the upheaval in the U.K. bond market two years prior led to the resignation of former Prime Minister Liz Truss. “Interest rates surged dramatically,” he remarked, “leading to the swift collapse of her government within days.”
