MNI INTERVIEW: Dec Fed Cut Doubtful If Trump Wins -Obstfeld
Former IMF chief economist Maurice Obstfeld discusses how Fed policy would shift under a second Trump term.
The Federal Reserve is likely to rethink a December interest rate cut if former President Donald Trump wins a second term and promises expansive fiscal policy, tariffs and tax cuts that would stoke inflation, former IMF chief economist Maurice Obstfeld told MNI.
Trump has floated plans for a 10% tax on all imports and a 60% tax on Chinese imports, revenues from which would help fund an extension of 2017 tax cuts on households and corporates. He's also vowed to shut the southern border and deport unauthorized migrants.
"Suppose we get to the December Fed meeting and Trump is elected and putting forth an inflationary set of priorities, what does the Fed do? They certainly wouldn't cut rates," Obstfeld said in an interview. "Maybe -- depending on what inflation is -- they could go in the other direction."
If Trump follows through after taking office, the Fed's reaction function would depend on the broader fiscal context and the health of the U.S. economy, he said.
TAX CUTS COULD MERIT HIKES
Thinktanks across the political spectrum have estimated the tariffs would raise expenses for a typical middle-income household by between USD1,700 and USD2,500 a year. They would come at a time when inflation is already elevated and rates at a 23-year high.
"The effect of tariffs on the domestic price structure would be pervasive," because domestic producers of competing goods will also be able to raise prices without losing market share, Obstfeld said. "We would expect significant price increases over a couple quarters," as higher prices of imported goods feed through to general price levels for tradeable goods that are substitutes.
"Taking the tariffs alone, the Fed could say this is a temporary effect on inflation. So unless it’s reflected in wages, which would have more persistent price pressures, maybe we shouldn’t do much for now and wait and see," Obstfeld said.
On the other hand, if Trump and Republicans in Congress extend or expand the provisions of the 2017 Tax Cut and Jobs Act, due to expire at the end of 2025, and new immigration restrictions cause a substantial tightening in the labor market, "maybe that would merit a rise in interest rates."
SEPTEMBER CUT POSSIBLE
There’s also "no question on the direction of travel" on how immigration restrictions would affect inflation, Obstfeld said, citing a recent Peterson Institute for International Economics study projecting a 1.3 percentage point rise in inflation and 2.1 pp drop in GDP over three years if 1.3 million undocumented workers are deported. Obstfeld is also a senior fellow at the Peterson Institute.
"The labor market would get even tighter without the flow of workers. If that’s cut off, it would lead to substantial tightening," he said. "That will lead to higher wages and higher costs for businesses and more inflation down the road. It will also lead to slower growth because part of what’s driving growth is an increasing workforce."
At the moment, the U.S. economy continues to show strength, and recession risk is below 50-50 barring a surprise hit to financial stability, Obstfeld said. (See: MNI INTERVIEW: Fed Already Well Behind The Curve On Cuts - Tracy)
The Fed could lower interest rates in September in light of weaker-than-expected data in recent weeks, he said, adding the short-run neutral rate has certainly risen, even if the very long-run natural rate of interest dictated by global productivity growth and demographics remains low at 1% at most.