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

Episode Summary

Executive Summary: This episode examines the Fed's first rate cut in over a decade and how it intersects with Trump’s new tariffs on Chinese imports. Adam Posen argues the cut reflects multiple Fed concerns—slowing global growth, trade uncertainty, weak inflation, and softer wage growth—but says tariffs mainly hurt growth quality and investment rather than causing immediate inflation. He also says the Fed is reacting more to global conditions than before, yet it cannot offset a sustained trade-war shock.

Main Topics: Why the Fed cut rates (Priority: 5/5): Posen explains that the committee reached the same rate-cut decision for different reasons: recession fears, trade uncertainty, weak wage growth, and low inflation expectations, with dissent over financial stability. The Fed’s shift toward global considerations (Priority: 5/5): The discussion focuses on Powell’s emphasis on global growth and trade risks, which Posen describes as a real change in how the Fed frames policy, though still justified through U.S. economic effects. Trade war effects on growth and investment (Priority: 5/5): Posen argues tariffs and trade uncertainty are depressing corporate investment and making growth lower quality, even if headline GDP remains positive due to fiscal stimulus and low rates. Why tariffs have not yet caused major inflation (Priority: 4/5): He says tariffs are taxes borne by U.S. businesses and consumers, but their economy-wide inflation effect is limited because trade is a small share of the total consumption basket and many costs are absorbed by firms. What monetary policy can and cannot do (Priority: 4/5): The episode emphasizes that rate cuts can help with financial panics but cannot repair the real-economy damage from ongoing trade-policy uncertainty or eroded trading norms. Trump, markets, and political interpretation (Priority: 3/5): Posen dismisses theories that the Fed is acting out of deference to Trump or to weaken the dollar, and argues the tariff escalation is unlikely to materially change China’s bargaining position.

Key Arguments: The Fed's rate cut was not driven by a single factor; different members supported it for different macroeconomic concerns, including recession risk, trade uncertainty, low wage growth, and falling inflation expectations. The Fed is placing more weight on international conditions than it historically did, because global developments now have larger effects on the U.S. economy than before. China's slowdown alone would not have been enough to trigger a Fed cut; the key issue is the broader trade-policy shock and uncertainty created by the Trump administration. U.S. growth around 2.5% is misleadingly strong because it is supported by fiscal deficits, low interest rates, and a relatively fair-valued dollar, yet corporate investment has been essentially flat, signaling weak future growth. Tariffs are paid largely by American consumers and businesses, but the price impact is muted in aggregate because most U.S. spending is on domestically determined items like housing, education, medical services, and gasoline. Inflation effects from tariffs will likely appear with a lag as existing inventory runs out and contracts are renegotiated, but they are not likely to create sustained broad inflation. The Fed cannot fix the core problem of reduced business confidence and higher risk from unpredictable trade policy; rate cuts may cushion but not reverse those effects. Theories that the cut was due to Trump’s pressure on the Fed or aimed at moving the dollar are rejected as implausible. Market participants should not assume that stock-market weakness alone will force Trump to reverse course, because tariff threats have become more routine and less constrained by market reactions. The Fed’s move is unlikely to materially alter Trump’s trade strategy or China’s willingness to concede on structural issues such as state-owned enterprises and intellectual property.

Data Points: Fed rate cut timing: First cut in over a decade - The episode opens by noting the Federal Reserve cut interest rates on Wednesday. New tariff rate: 10% - Trump announced a 10% tariff on the remaining $300 billion of Chinese imports. Remaining Chinese imports targeted: $300 billion - The new tariff was aimed at the remaining Chinese imports not already hit. Prior tariff increase: 10% to 25% - The discussion references a previous tariff increase on roughly $200 billion of Chinese imports. Tariff-covered imports: Around $200 billion - The mid-June tariff increase applied to this value of Chinese imports. U.S. GDP growth: 2.5% plus - Posen says the U.S. economy has still been growing decently despite trade tensions. Corporate investment: Essentially zero over the last 1.5–2 years - He uses flat investment as evidence that growth quality is weak. Time since last comparable U.S. tariff episode: About 80 years - Posen notes the challenge of modeling tariffs because the last similar episode was Smoot-Hawley in the 1930s. Insurance cut precedent: 1998 - He cites 1998 as the biggest prior example of a Fed rate cut influenced by international turmoil. Fed committee size: 12 Reserve Bank presidents and up to 7 Board members - Used to explain why different members can support the same vote for different reasons.

Pivotal Quotes: "The position of the economy is as close to our objectives as it's been in a long time, and the outlook is also good." — Jerome Powell: Powell at the press conference describing why the Fed could still cut rates. "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 on the Fed’s greater emphasis on global conditions. "Tariffs are a tax. It's American businesses and American consumers who are paying the tax." — Adam Posen: Posen explaining why tariffs may not show up immediately in inflation but still hurt households and firms.

Implications: Listeners should expect the Fed to cushion trade shocks only modestly. Businesses may face continued investment uncertainty, delayed tariff inflation, and more volatility in growth, while markets should not assume rate cuts will stop the trade war or restore stable trade norms.