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Introduction: Tom Lee’s Non-Inflationary Thesis

In a recent interview, Tom Lee made a convincing but incomplete argument for team non-inflationary when describing the economic impacts of tariffs. From Lee’s perspective, a tariff is a tax that simply reallocates money in the economy. Money transfers from companies and/or consumers in the supply chain to the government. That money goes right back into the economy through government spending. Thus, money just flows from one set of hands to another. This argument relies on a monetary theory of inflation, where an increase in the money supply is the main driver of inflation; tariffs do not increase the money supply.

The Limits of Monetarism in Today’s Economy

Milton Friedman made monetary theory, or monetarism, famous through quotes like: “Inflation is always and everywhere a monetary phenomenon.” Monetarism seemed to work well to explain the economy of the 1970s and 1980s but waned over time according to the IMF. Still, given the fluid and dynamic nature of today’s economies, I am fully willing to accept that monetarism can and will become relevant under the right circumstances. Today’s tariff regime is not creating the right circumstances.

Tariffs, Wages, and Supply Chain Reactions

Because Lee thinks of tariffs as a transfer of money from people and companies to the government, he implied that instead of hiking rates to counteract inflationary effects, the Fed should cut rates in order to counteract a drop in demand from higher prices. However, Lee does not explicitly account for the potential responses to tariffs across the supply chain. As prices rise, consumers may ask for higher wages to cover increased costs in the economy. These higher wages are in turn paid for with higher prices. And so on. Federal Reserve Governor Christopher Waller countered this fear by insisting that today’s economy does not grant workers such economic power, certainly not like they had in the immediate wake of the pandemic. However, as strict immigration policy tightens the U.S. workforce, remaining workers in significant portions of the economy could find themselves with renewed economic power to demand higher wages to offset any real or perceived tariff-driven cost increases. The final or net impacts are hard to predict.

Demand Destruction and Fed Caution

Consumers will find little comfort or relief knowing that their higher costs boost government coffers. For example, the recent budget bill held as a premise that money is better left in consumer pockets and corporate treasuries than in government accounts. Thus, a tariff-induced price hike will induce responses from the payers of that tax in order to offset real economic impacts. In the interview, Lee appears to lean toward demand destruction as the deflationary counterbalance that can relieve pressure on consumers. Yet, with the looming uncertainty about the path of tariff policy and its eventual impacts, the Federal Reserve is well-served to proceed with caution. For example, cutting rates to offset demand destruction could entrench the inflationary impulse that pressured demand. In the optimistic scenario, the Fed could do well to wait on businesses and suppliers to work out efficiencies to avoid passing on tariff costs into the rest of the economy.

The Inflationary Impact Is Real and Already Here

In the middle of all the swirl on inflationary impacts from tariffs comes a recent Federal Reserve study that has already detected inflationary impacts from the current tariff regime and has concluded that the first trade war with China from 2018–2019 also boosted inflation. From “Detecting Tariff Effects on Consumer Prices in Real Time“:

“…we find that US import tariffs led to a statistically significant increase in consumer goods prices. For the 2018–19 tariffs, our local-projections approach reveals that tariff changes were passed through fully and quickly—within two months of tariff implementation—to consumer goods prices. For the February and March 2025 tariffs implemented on imports from China, we find that tariffs have already passed through partially to the consumer goods prices that we can observe through March. Our results indicate that the 2025 tariffs have so far led to a 0.3 percent increase in core goods PCE prices, contributing to a 0.1 percent increase in core PCE prices (goods and services prices, excluding food and energy) as a whole.”

An illustrative research paper from the San Francisco Federal Reserve, “The Effects of Tariffs on Inflation and Production Costs” by Bart Hobijn and Fernanda Nechio, makes an even more stark case for the inflationary impacts of tariffs:

“Estimates suggest that the impact on prices for investment goods is likely to be much larger than for consumption goods. For example, if an across-the-board 25% tariff is fully passed through to finished goods, near-term price increases are estimated to be about 9.5% for investment goods and 2.2% for consumption goods.”

Hobijn and Nechio further explain that “the import content is much larger for investment goods than for consumption goods. This is because domestic markups tend to be smaller for investment goods than for consumer goods, making the import content of their costs much larger.”

Thus, even if aggregate inflation somehow sustains minimal impact because of fortuitous offsets, significant parts of the economy could suffer. Without tariffs, the inflation rates in both periods could have been lower. With inflation still above the Fed’s 2.0% target, a cut in rates in the middle of so much uncertainty carries all types of risks.

Bostic Speaks for Team Inflation

In commentary hearkening back to the warning signs from the last Beige Book, Raphael Bostic, President of the Atlanta Federal Reserve, cautioned in a CNBC International interview that the Fed’s business contacts have clearly signaled their willingness and readiness to raise prices in response to tariffs. In commentary that could be referencing the recent Fed study, Bostic also claimed that inflation is already showing up in current tariffs. Most interesting to me in this inflationary story is Bostic’s counter to the theory posed by Waller and others that tariffs create a one-time price shock and then inflation just goes back to normal (emphasis mine):

“The textbook story for economics is if you do tariffs, it’s a one-time shift. It happens quickly. Everyone understands what’s going on and then the world goes back to how it was before. So you should look through that. What we are seeing today though is not just a one-time shift. It’s actually something that’s being stretched out over a much longer period of time. I think that runs the risk that people start to feel like inflation is always with them. This elevated level of inflation is always with them. And that then runs the risk that there might be some structural changes that businesses and consumers, for that matter, make in terms of how they respond and how they engage in the marketplace.”

Bostic sums up very well why the Fed must proceed with caution. Without clarity on the shape, timing, or magnitude of tariff policy, predictions and models are precarious. Rushing to cut rates risks worsening any upcoming inflation surprises.

Bostic also has support in other economic research. The following quote from an NBER working paper, “Tariffs As Cost-Push Shocks: Implications for Optimal Monetary Policy” by Iván Werning, Guido Lorenzoni, and Veronica Guerrieri, suggests that calls to “see through” tariff shocks represent more economic bravery than some may admit (emphasis mine):

“A widely held tenet in the practice of central banking is that a shock like a tariff shock, that entails a mechanical increase in some prices, is a shock that requires the central bank to “see through it”, in other words, to let the mechanical effect of the tariff in prices to affect the overall price level, but avoid
larger increase in prices. To be fair, this is a rule of thumb which, as far as we know, does not correspond to any result in economic theory.”

Conclusion: Stagflation at the Center

Ultimately, all this back and forth on the potential inflationary impact of tariffs tells me that stagflation remains front and center in the economic window. The Fed is right to remain cautious, but as time drags on, economic risks increase for both inflation from tariffs and for an economic slowdown from demand destruction or even ongoing cyclical factors. Today’s predictions will turn out wrong in surprising ways. The Federal Reserve is caught in a tough position where it needs to wait but may find the rising risks and costs of waiting increasingly difficult to absorb.

The staglfationary risks and dilemmas come through in the following quote from the NBER working paper:

“Is a tariff expansionary or contractionary? The answer depends on how monetary policy responds… Based on our equivalence result, a tariff is best understood as a supply-side disturbance—not a demand-side disturbance—that introduces a trade-off for monetary policy. If the central bank prioritizes price stability, the tariff will lead to a sharp short-run contraction. Alternatively, the central bank can offset this contraction by pursuing an expansionary response. In sum, the notion of a “neutral” monetary policy is not well defined.”

In the meantime, I remain committed to Goldman Sachs Access Inflation Protected USD Bond ETF (GTIP) as my hedge on the Fed’s increasingly precarious stagflationary bind. For now, the ETF has bounced around at the whims of long-term Treasury bonds, vacillating from nervousness over the U.S.’s ballooning debt to reassurances over the economy to mild flight-to-safety flows.

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Source: Tradingview.com

Be careful out there!

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