94: The Fed and the Trade War, with Adam Posen

Episode Summary

Executive Summary: The episode examines the Fed’s first rate cut in over a decade alongside Trump’s new China tariff threat, arguing the cut reflected multiple concerns: recession risk, weak wage/inflation dynamics, and especially global trade uncertainty. Guest Adam Posen says the Fed is increasingly weighing world conditions because they now affect the U.S. more directly, but rate cuts won’t fix the real-economy damage from tariffs and policy uncertainty.

Main Topics: Fed rate cut and mixed motivations (Priority: 5/5): Adam Posen explains the July 31 rate cut as a committee decision driven by several different concerns: recession risk, trade uncertainty, weak wage growth, low inflation expectations, and financial stability concerns from dissenters. Fed’s growing attention to global conditions (Priority: 5/5): The discussion emphasizes a shift in Fed thinking: international developments, especially Europe and China, are now central because they affect U.S. growth, capital flows, inflation, and rates more than in the past. Trade war’s effect on growth quality (Priority: 5/5): Posen argues the U.S. economy’s growth looks decent on the surface but is being supported by fiscal stimulus, low rates, and a moderate dollar, while corporate investment is unusually weak, signaling poor-quality growth. Tariffs, inflation, and pass-through (Priority: 4/5): The speakers discuss why tariffs have not yet produced large inflation readings, noting delays in pass-through, firms absorbing costs via lower margins, and the fact that many major price categories are domestically determined. Limits of monetary policy against trade policy (Priority: 5/5): They stress that cheaper borrowing can’t offset the damage from ongoing trade uncertainty and a breakdown in contract/investment confidence caused by tariffs and trade-policy volatility. Market reaction and Trump incentives (Priority: 4/5): The conversation rejects the idea that the Fed cut was mainly about pleasing Trump or driving the dollar, and questions whether stock-market moves reliably constrain Trump’s trade behavior anymore. Forecasting uncertainty and policy modeling (Priority: 3/5): Posen notes that economists lack good models for tariff effects because the last major U.S. tariff episode was decades ago and standard models assume exchange rates adjust more than they likely will.

Key Arguments: The Fed’s rate cut was not based on one simple motive; different FOMC members supported it for different reasons, making Powell’s explanation seem ambiguous. The Fed is placing more weight on international developments because global weakness now has larger spillovers to the U.S. economy than in the past. China’s slowdown alone would not move the Fed; what matters is how U.S. tariff policy affects U.S. consumers, firms, and the trading system. U.S. growth appears healthy only after accounting for large fiscal deficits, already-low interest rates, and a relatively fair dollar; under those conditions, corporate investment should be stronger than it is. Weak corporate investment is evidence that trade uncertainty and policy disruption are hurting the economy’s future productive capacity. Tariffs are taxes paid by U.S. businesses and consumers, but their inflationary impact is muted because firms can absorb costs and many consumer prices are domestically set. Tariff effects on prices are lagged, so some inflationary pass-through may still appear later. Trump’s pressure on the Fed is mostly noise; Congress is the institution the Fed truly fears, and Congress has largely defended Fed independence. The Fed cutting rates is unlikely to materially change Trump’s bargaining position or convince China to make deeper structural concessions. Stock-market reactions no longer reliably discipline Trump, because repeated threats have eroded investor confidence that a deal or stopping point will emerge. Rate cuts help most when the problem is financial panic; they are much less effective when the underlying issue is a real-economy shock from trade policy. Current macro models are poorly equipped to estimate tariff effects because they rely on assumptions that may not hold in this episode, especially exchange-rate adjustment.

Data Points: Fed policy move: First interest-rate cut in over a decade - The Fed cut rates on Wednesday, described as its first cut in more than ten years. China tariff announcement: 10% tariff - Trump announced a 10% tariff on the remaining $300 billion of Chinese imports not already hit. U.S. GDP growth: 2.5% plus - Posen says the U.S. economy has been growing decently, even after revisions. Corporate investment: Essentially zero over the last year and a half to two years - Used to argue growth quality is poor despite headline GDP strength. Tariff increase: 10% to 25% - Latest round of tariffs on about $200 billion of Chinese imports, implemented in mid-June. Tariff-covered imports: About $300 billion - Remaining Chinese imports subject to the newly announced 10% tariff. Tariff-covered tranche: Around $200 billion - Previous tariff escalation discussed as having moved from 10% to 25%. Committee composition: 12 Reserve Bank presidents and up to 7 Board members - Explains why the Fed’s decisions can reflect multiple rationales. 1998 comparison: Insurance cut amid Russia and South Korea crises - Historical example of the Fed factoring in international financial stress. Modeling horizon: 80 years since Smoot-Hawley - Used to explain why economists lack modern precedent for U.S. tariffs at this scale.

Pivotal Quotes: "The position of the economy is as close to our objectives as it's been in a long time." — Jerome Powell: Powell’s press conference explanation for why the Fed could cut rates despite a generally strong economy. "It's not so much that they're caring much more about the rest of the world... but it is a change that they're putting international developments front and center." — Adam Posen: Posen describing the Fed’s increased attention to global conditions and trade-related uncertainty. "Tariffs are a tax. It's American businesses and American consumers who are paying the tax." — Adam Posen: Posen’s explanation of why tariffs can hurt U.S. prices and margins even if inflation data has not yet surged.

Implications: For businesses, the big risk is not just tariffs themselves but prolonged uncertainty that suppresses investment. For markets, Fed easing may not offset trade damage. For policymakers, the episode shows the Fed now treats global spillovers as central, not peripheral.