The Economic Falter: How Tariffs Cause a Downward Spiral
Persistent economic instability is causing escalating worry about an unfavorable economic condition, known as stagflation.
In a candid discussion on The Big Money Show, Steve Forbes delves into the international fallout of escalating trade tensions between the U.S. and China, particularly focusing on the economic implications of tariffs.
President Donald Trump's trade policies have sewn uncertainty into the economy, causing concerns about stagflation - a situation where economic growth stalls whilst inflation soars, leading to rising consumer prices and potentially a weak labor market.
Tariffs function as taxes on goods imported into the country, with importers absorbing some or all of these increased costs and passing them on to consumers in the form of higher prices. This dynamic fuels worries about a re-emergence of inflation. Over the past few months, consumers' expectations of inflation have surged in Federal Reserve surveys, anticipating tariff-induced price hikes on a variety of consumer goods.
Recent economic data adds fuel to the anticipated stagflation fire. Data from the Commerce Department shows that the U.S. Gross Domestic Product (GDP) shrank by an annual rate of 0.3% in the first quarter of 2025 - the first such contraction since early 2022.
*U.S. GDP plunges 0.3%: a warning shot*
Economic turmoil wrought by tariffs could tip the U.S. into stagflation. (Spencer Platt/Getty Images)
Ellen Zentner, Morgan Stanley Wealth Management's chief economic strategist, labeled the report as a cautionary "stagflation warning shot" to the economy. She contends that the Fed will be hard-pressed to placate jittery markets with such weak GDP figures, and it won't make life any easier for Chair Jerome Powell as he balances the central bank's dual mandate of price stability and full employment during this uncertain climate.
David Bahnsen, managing partner and chief investment officer of the Bahnsen Group, spoke with FOX Business and underscored the challenges posed by a stagflationary environment for the Federal Reserve. According to Bahnsen, a stagflationary environment would pose problems for the central bank, as the reason for higher prices wouldn't stem from monetary factors but rather external pressure from tariffs and rising input costs, territory that lies beyond the Fed's control.
*U.S. Trade Deficit hits a record high in March*
Stagflation poses a challenge for Fed Chair Jerome Powell as the central bank navigates its dual mandate. (Alex Wong/Getty Images)
Bahnsen suggests that whilst he expects the Trump administration to pare back most of its tariffs eventually, allowing price hikes to unwind, the prolonged uncertainty surrounding the length and extent of the tariff policy could lead businesses to pull back investments as they crave greater clarity, causing an economic slowdown.
"I don't believe that the price increases are going to be permanent," Bahnsen shared. "I think the Trump administration will eventually take a step back on most of the tariffs they've threatened. My bigger concern, however, is the stagnation - what will be the economic slowdown due to these policies?"
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"I don't have the ability to answer it," Bahnsen concluded. "I can't predict how long the uncertainty will last or if the administration will rescind all the tariffs. The magnitude and duration of the economic impact are dependent on factors that we don't have full visibility on right now."
Enrichment Data:
The long-term ramifications of tariffs on the American economy, particularly within a stagflationary landscape with stagnant growth and escalating inflation, can be far-reaching and predominantly harmful. Here's a closer look at the impact based on recent economic assessments and insights:
Negative Long-Term Effects of Tariffs on the American Economy
- Declining Economic Growth and GDPTariffs increase the cost of imported inputs for U.S. businesses, raising production costs and resulting in drops in overall economic efficiency and output. Research suggests that tariffs may reduce long-run U.S. GDP by roughly 0.6% to 1.0%, with certain models projecting more significant negative impacts, such as a 6% reduction in long-run GDP under extensive tariff plans[2][4][5].
- Eroding Household IncomesHigher production costs and reduced economic growth lead to lower wages and reduced purchasing power for households. Studies predict that wages may fall by about 5% in the long run, translating to significant lifetime income losses for middle-income households (e.g., approximately $22,000 per household)[2].
- Inflationary PressuresTariffs raise the prices of imported goods, adding to consumer price inflation. For instance, the 2025 tariffs could lead to a 2.9% short-term increase in consumer prices, substantially depleting household purchasing power[4].
- Higher Unemployment and Strained Labor MarketsEconomic stagnation caused by tariffs may prompt unemployment to rise. Projections suggest an increase in the unemployment rate by about 0.55 percentage points and a decrease in payroll employment by approximately 740,000 jobs in the short run[4].
- Reduced Trade Openness and Capital FlowsTariffs decrease economic openness and can disrupt international capital flows. This restriction in openness can raise domestic borrowing costs and lower private investment. The subsequent decline in capital investment productivity further dampens economic growth[2].
- Elevated Economic UncertaintyTariffs frequently create unbalanced and unstable trade relations, increasing uncertainty for businesses and consumers. This uncertainty can reduce consumer and business confidence, exacerbating economic slowdowns[3].
Fed's Response in a Stagflationary Environment
In the presence of tariffs driving up inflation while inhibiting growth, the Federal Reserve faces a tough balancing act:
- Inflation Targeting vs. Growth SupportThe Fed typically counteracts inflation by raising interest rates. Nevertheless, in a stagflationary context with sluggish growth and rising unemployment, aggressive rate hikes might aggravate the economic downturn.
- Managing Inflation ExpectationsAs tariffs fuel inflation, the Fed may be compelled to maintain tighter monetary policy for longer to keep inflation expectations steady, even if growth is weak[3].
- Limited Room for Rate CutsIf investors perceive the inflationary impact of tariffs as a temporary phenomenon, the Fed might slow the pace of tightening or delay rate cuts, weighing the risks to growth and inflation[3].
- Focus on Long-Term StabilityThe Fed could emphasize forward guidance and communication to manage market expectations, aiming to avoid further shocks from tariff-induced uncertainty.
In essence, tariffs introduce complexity to the Fed's dual mandate of price stability and maximum employment, necessitating caution and potentially accepting slower growth to prevent inflation from becoming deeply entrenched.
- The implementation of tariffs by President Donald Trump has raised concerns about stagflation, a economic condition where growth stalls while inflation soars, leading to rising consumer prices and potentially a weak labor market.
- Tariffs function as taxes on goods imported into a country, with importers absorbing some or all of these increased costs and passing them on to consumers in the form of higher prices, fueling worries about a re-emergence of inflation.
- In a stagflationary environment, economic growth may stall, and the Federal Reserve may face challenges in addressing the inflated prices, as the reason for higher prices wouldn't stem from monetary factors but rather external pressure from tariffs and rising input costs.
- Recent economic data, such as the U.S. Gross Domestic Product (GDP) shrinking by an annual rate of 0.3% in the first quarter of 2025, adds fuel to the anticipated stagflation fire.
- David Bahnsen, a chief investment officer, suggests that the prolonged uncertainty surrounding the length and extent of tariff policy could lead businesses to pull back investments, causing an economic slowdown.
- In such a stagflationary environment, the Fed may balance its dual mandate of price stability and full employment by managing inflation expectations, maintaining tighter monetary policy for longer, and limiting its room for rate cuts.
- To join the discussion on the dynamic impacts of tariffs on the economy, finance, and business, stay informed with Fox Business, providing the latest insights and analysis on the market trends by 2025 and beyond.
