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I am seeing a lot of claims about how tariffs are likely to impact the economy. Here are a few of my views on the issue:

1. The most important impact of tariffs is not their effect on inflation.

2. The most important impact of tariffs is not their effect on the business cycle.

3. Most economists overestimate the impact of “real shocks” such as tariffs on inflation and the business cycle.

4. The most important economic impact of tariffs is on long-run economic growth. (There are other non-economic impacts, such as increased risk of war.)

5. Most economists do not overestimate the impact of tariffs on long-run growth.

6. The impact of tariffs on the business cycle and inflation depends largely on the response of monetary policymakers.

7. Monetary policy has almost no impact on how tariffs affect long-run growth.

8. When most average people think about how “the economy” is doing, they think in terms of the business cycle and inflation, not the far more important trends in long-run growth.

9. There is “a great deal of ruin in a nation,” and hence even large real shocks usually have seemingly small effects on long-run growth. But those seemingly small effects are actually quite important. A 0.2% decline in long-run growth is far worse than a 2% fall in GDP for a single year.

Put these nine points together, and you have a recipe for widespread misunderstanding regarding the recent trade war. I don’t know how much monetary offset we are likely to get, and I don’t know how much the administration will adjust tariffs in the weeks and months ahead. Thus, it’s impossible to offer unconditional forecasts on inflation and the business cycle. But I will offer a few tentative observations.

1. The current level of tariffs, by itself, is probably not enough to trigger a recession. Nonetheless, a recession is possible due to the interaction of tariffs and monetary policy. Put simply, the trade war will reduce the equilibrium or natural rate of interest, likely making monetary policy tighter in 2025. I would recommend rate cuts if not for the fact that the previous monetary policy has been too expansionary and inflation remains a significant problem.

2. The recent GDP figures understate growth in the economy during Q1. Actual growth was likely higher than reported because a large amount of inventory accumulation was missed. Put simply, lots of goods showed up (at the docks) as a negative in the import category, but have not yet been listed as a positive in “inventory investment” (in warehouses). For the same reason, Q2 growth will almost certainly be overstated. Focus on monthly data like the jobs report to see what’s actually going on.

3. The administration faces an interesting dilemma. It can avoid recession by backing off on the trade war, at the cost of failing to address the trade deficit. Or it can press ahead with a more aggressive trade war, at the cost of risking recession. Recessions usually reduce the trade deficit. 

4. I view manufacturing as overrated. But if we must obsess about manufacturing, it would make far more sense to bring back manufacturing output than it would to bring back manufacturing employment. I.e., chip-making, not iPhone assembly.

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