Economic Outlook Amidst Uncertainty: A Deliberate Look at Tariffs and Inflation

Strategic Insights -

As we navigate through the complexities of trade policy, economic uncertainty has become a defining feature of our time. The recent landscape surrounding tariffs has led to a heightened sense of uncertainty among households, businesses, and financial market participants. Against this backdrop, I'd like to take a closer look at the data and assess the effects of tariffs on the economy.

Key Takeaways:

  • Concerns about tariffs have been widespread, resulting in a reported pullback on capital spending, with the national Survey of Consumer Expectations (SCE) showing that consumers' uncertainty along a number of dimensions remains elevated.
  • Despite the elevated uncertainty, some soft data have provided more encouraging news, with longer-run inflation expectations remaining stable, while short- and medium-term inflation expectations have returned to their pre-pandemic ranges.
  • The U.S. economy remains in a good place, with real GDP growth data suggesting that economic growth has slowed relative to last year's pace, largely reflecting effects from the front-running of tariffs earlier this year.
  • The effects of tariffs on core goods prices are starting to emerge, with initial effects visible on price increases for items exposed to higher tariffs, such as household appliances, musical instruments, and luggage.
  • The relationship between tariff exposure and price increase is positive, indicating that tariffs are having a noticeable impact on prices.
  • Businesses are expecting to respond to tariffs by increasing prices, with a special New York Fed survey of businesses indicating that firms passed on at least some of the higher tariffs to their customers.
  • The expected effects of tariffs on inflation are significant, with an estimate of a 1 percentage point boost to inflation over the second half of this year and the first part of next year.
  • The lower foreign exchange value of the dollar will also add to inflationary pressure, but the magnitude and timing will depend on various factors and data.
  • Monetary policy will continue to be closely monitored, with the FOMC maintaining a modestly restrictive stance to achieve maximum employment and price stability goals.
  • The FOMC will continue to reduce its holdings of Treasury securities and agency debt and agency mortgage-backed securities, a process that has been going smoothly.

Statistics:

  • The national Survey of Consumer Expectations (SCE) shows that consumers' uncertainty along a number of dimensions remains elevated, with a pullback on capital spending reported.
  • Long-run inflation expectations have remained stable, while short- and medium-term inflation expectations have returned to their pre-pandemic ranges.
  • Real GDP growth data have been unusually noisy, reflecting effects from the front-running of tariffs earlier this year, with a slowdown in growth relative to last year's pace.
  • The effects of tariffs on core goods prices are starting to emerge, with initial effects visible on price increases for items exposed to higher tariffs.
  • The relationship between tariff exposure and price increase is positive, indicating that tariffs are having a noticeable impact on prices.
  • Net tariff receipts as a share of imports rose from about 2-1/4 percent in the first three months of the year to about 8 percent in May.
  • Businesses expect to respond to tariffs by increasing prices, with a special New York Fed survey of businesses indicating that firms passed on at least some of the higher tariffs to their customers.
  • The FOMC has maintained a modestly restrictive stance to achieve maximum employment and price stability goals, with a target range for the federal funds rate remaining unchanged at 4-1/4 to 4-1/2 percent.
  • Estimates of the average effective tariff rate range somewhere between 15 and 20 percent, but actual tariffs in effect in recent months were much smaller than that.

Sources:

  • New York Fed Survey of Consumer Expectations (SCE)
  • National Bureau of Economic Research (NBER)
  • Federal Reserve Economic Data (FRED)
  • Bureau of Labor Statistics (BLS)
  • Bureau of Economic Analysis (BEA)
  • Federal Open Market Committee (FOMC)
  • Bank for International Settlements (BIS)
  • Organisation for Economic Co-operation and Development (OECD)