Since March 2021, when inflation began to significantly exceed the target of 2%, more than four years have passed, and the Federal Reserve has not brought the inflation rate back to 2%. Currently, Trump's tariff war is expected to bring new price-raising pressures, and the tax reduction plan may provide additional economic stimulus. High inflation is likely to enter its fifth year, whereas the well-known stagflation of the 1970s lasted 'only' ten years. The Federal Reserve's persistent pursuit of the 2% inflation target is long and arduous, reminiscent of Gabriel Garcia Marquez's 'Love in the Time of Cholera.'
Tariffs and Prices: Where have they risen to?
After the "suspension" of tariffs on April 9 and May 12, negotiations between the United States and its major trading partners, the EU, China, and Japan, have not yet yielded results. However, with nearly two months of more complete data on the newly imposed tariffs that are already in effect, we can roughly estimate the impact of the tariffs on prices.
According to the Bipartisan Policy Center, a U.S. think tank, the cumulative total tariffs collected by U.S. Customs for the year as of March 22, 2025 will be $26.5 billion, and by May 22, 2025, the above figure will become $67.3 billion; The figures for the same period in 2024 are $17.7 billion and $33 billion, respectively. The tariffs imposed between March 22 and May 22, 2025, will be $40.8 billion, $26 billion higher than the same period in 2024. The total value of U.S. imports in these two months is about $640 billion, and if the tariff burden is borne by U.S. buyers and is added to the final sales price, the price increase of imported goods should be about 4% (4 the timing of the implementation of the new tariffs in the month is more complete, the tax rate is higher, and the proportion of the price increase should be larger, about 3%). In the total household consumption of the United States, imported consumer goods are about 1.7 trillion yuan, accounting for 8.5%, so tariffs should push up the CPI in April by about 0.3% month-on-month, considering the original trend level, the April CPI should be 0.5% month-on-month.
However, the CPI data released in April is far from that. The CPI growth rate in April was 2.3% year-on-year and 0.2% month-on-month, both at low levels in recent months. Some products with a high proportion of imports, such as clothing and toys, had zero price changes month-on-month, communication electronics were almost flat month-on-month, and medical supplies rose 0.4% month-on-month. There can be several explanations for the above contradictions, one is that imports and inventory accumulation, so the price will not rise for the time being, but it will rise later; Another possibility is that foreign exporters bear the lion's share of the tariff burden, so U.S. domestic retail prices don't have to rise much. These explanations will take time to verify, but in either case, we can analyze a medium- to long-term economic "steady state" after tariffs are imposed.
Tariffs and "Double Reduction": A Long-term Analysis
In a long-term open economy, reducing the fiscal deficit will increase overall savings. The excess savings of a country can be used for domestic investment or for foreign investment. One way to increase foreign investment is to export more, "earn more money from foreigners," and hold more foreign currency assets, which is also reflected in trade as a reduction in the trade deficit (or an expansion of the trade surplus). As net exports increase, the fiscal deficit needs to decrease to maintain output stability. This "dual reduction" is what the United States urgently needs at present.
There are several very different ways to reduce the trade deficit, for example, through the depreciation of the dollar or through the imposition of import duties. The depreciation of the dollar reduces the trade deficit by making U.S. goods cheaper (relative to foreign goods) and boosting external demand. Tariffs, on the other hand, reduce U.S. exports (because tariffs will increase the value of the dollar), but also reduce U.S. imports (imports become more expensive with taxes), and the trade surplus widens because imports fall even more. In other words, the United States, as a trade deficit country, has become more closed through tariff barriers, and the purchasing power of the United States has shifted more to its domestic products, which will lead to an increase in domestic demand in the United States, thereby reducing the trade deficit (the trade deficit of a fully closed economy will be zero).
As I have analyzed in a previous article in this magazine, part of the tariffs are borne by domestic residents, which is equivalent to a forced price increase to subsidize local products (it needs to be remembered that price increases can incentivize local production); Part of it was borne by overseas exporters, who were forced to lower the price of their exports (earning fewer dollars for the same exports), amounting to a transfer payment to the U.S. government. Suppose that the U.S. trade deficit and fiscal deficit were both $900 billion before the tariffs were imposed; After the tariff is imposed, it is assumed that the tariff revenue will increase by 400 billion, half of which will be borne by the United States domestically, and the other half will be borne by foreign exporters at a reduced price (for the sake of simplicity, changes in the dollar exchange rate are not taken into account here); Suppose tariffs cause the trade deficit to fall by 200 billion.
In order to keep aggregate demand unchanged, the decline in the trade deficit of 200 billion yuan (expansionary) needs to match the decline of the fiscal deficit of 200 billion dollars (contractionary), and the 200 billion in tariffs levied by the country is the tightening of aggregate demand, which is exactly matched by the decline in the trade deficit, so this part of the tariff revenue does not need to be spent again (so as to achieve the effect of tightening demand), and can be used to redeem the existing debt. The other $200 billion in tariffs (equivalent to international transfers) will not have a contractionary effect on aggregate US demand, so they should all be used to reduce existing debt. In this example, the trade deficit has fallen, but the fiscal deficit can fall even more, while the macroeconomy remains at full employment. The significance of the conclusion that the fiscal deficit may have fallen more than the trade deficit cannot be ignored, and according to the author's reading, this analysis is not currently considered by the mainstream view on Wall Street.
The long-term outlook looks promising, but the specific path from the current "short term" to the aforementioned "long term" requires more analysis.
Short-term "unconventional" stagflation
In the early stages of tariff implementation, the rise in the price of imported goods will lead to a decline in the total supply of the United States, which means that the hedge between inflation and unemployment has deteriorated. With the same unemployment rate, the inflation rate will be higher, and the more academic term is the upward movement of the Phillips curve. Generally speaking, the movement of the Phillips curve is caused by inflation expectations, imagine that people have a rough consensus about the future inflation rate, and then set product prices and wages based on this. However, the change in supply brought about by tariffs is completely different, it is caused by actual price increases, and this increase is due to tariffs, as if the price increase was forced by executive order. This small difference makes a big difference in the conclusion.
Higher inflation expectations lead to a contraction in supply, but does not affect aggregate demand. The supply crunch caused by tariffs, on the other hand, will automatically tighten monetary conditions due to the real rise in prices, which will lead to higher real interest rates, while higher interest rates will dampen aggregate demand in the short term (and uncertainty will also affect investment), which will increase the probability of a recession. As mentioned above, tariffs "withhold" domestic demand to promote domestic demand, but if the deterrent effect of rising prices is greater in the short term, then the market will be worried about a recession, which can explain the market decline from February to April to a considerable extent.
Unlike loose monetary policy, the price increases caused by tariffs are passive and are the result of actual taxation leading to passive price increases by businesses. Once the price transmission is fully completed, the price increases will also come to an end. It is hard to imagine that during periods of weak demand (even though prices are rising), the market will form higher inflation expectations. Therefore, tariff-induced stagflation is a new phenomenon, and different from the "conventional" stagflation that people are familiar with in history; it is likely to be temporary.
"The Peak and Rate Cuts of "Unconventional" Stagnation
The process of rising prices due to tariffs was completed at a time when monetary policy was at its tightest, as prices were at their highest and the Fed kept interest rates steady in order to stabilize inflation expectations, which was probably the "darkest hour" for the economy. However, the worst time for price increases is also when the tariff shock is about to exhaust, and the timing of interest rate cuts will come with it. Interest rate cuts will stimulate aggregate demand, and international capital outflows from lower interest rates will also benefit exports. If fiscal policy is tightened at this time, it will be the beginning of a "double decline" in the economy, thus moving towards the aforementioned long-term goals.
The Fed's March economic outlook predicts that inflation will not return to 2% until 2027, but this forecast comes at a time when "reciprocal tariffs" and tax cuts have not yet been introduced. In a speech in Chicago in April, Powell expressed serious concerns about tariffs, saying that both inflation and the labor market were under pressure, triggering a plunge in the stock market on the same day. This provoked extreme displeasure from Trump, who demanded that the Fed cut interest rates and claimed that he had the right to remove Powell. At a press conference after the May Fed meeting, Powell once again highlighted the twin risks of rising inflation and a weaker labor market. The high level of uncertainty has led the Fed to adopt a "wait and see" strategy.
In contrast to the "dilemma" attitude of most Fed governors, Waller expressed a clearer view in a recent interview, arguing that the Fed should be brave enough to admit that the inflation caused by tariffs is transitory, and that it should cut interest rates decisively if there are signs of weakness in the labor market, which is close to the "unconventional stagflation" stance of the previous author. In its May policy statement, the Fed still viewed the labor market as strong, but some indicators have hinted at concerns, with the recent ratio of job openings to unemployed in March approaching 1, which is already below the pre-pandemic consensus of normal (1.2). Another factor that should not be ignored is that the demand for services and goods is substituted for each other, and if the price of goods increases, then the demand may shift more to services, so the overall price increase will not be so large. In addition, lower real incomes due to higher commodity prices will also contribute to a slower increase in service prices.
The current policy interest rate is contractionary, and there should be little doubt about this. Inflation will eventually slow down, but the timing is full of uncertainty. The short-term path analyzed in this article includes two phases: "unconventional stagflation" and "interest rate cuts." However, the progress of trade negotiations and the final scale of fiscal tax cuts will bring more variables. A 2% inflation target is very appealing, but the Federal Reserve's pursuit of it is extremely challenging, much like the "Love in the Time of Cholera" in the writings of Márquez.
The reaction of US stocks and US bonds
In the days following Trump's announcement of reciprocal tariffs from mid-February to early April this year, the ten-year interest rates and US stocks showed good synchrony. The market was concerned about the economic recession caused by tariffs, and thus when US Treasury yields fell, the stock market also tended to decline.
There was an abrupt change in the situation between April 7 and April 9, with the 10-year Treasury rate rising 33 basis points in three days, financial markets showing signs of panic, Treasuries no longer being considered safe, and demand for cash expanding sharply. This extreme anomaly can only occur during times of extreme panic, such as the extreme panic over the coronavirus pandemic that caused the 10-year Treasury rate to rise sharply from 0.54% to 1.18% between March 9 and 18, 2020. The three-day plunge in stocks and bonds crushed Trump's confidence in the tariff plan, and on Wednesday afternoon, April 9, the White House hastily announced a tariff pause.
On April 11, the Treasury rate rose to a stage high of 4.48%, then fell rapidly to 4.17%, and then rose again to 4.58% on May 21, which is roughly a V-shape. This extreme volatility reflects a high degree of macroeconomic uncertainty, with different signals of "stagnation" and "inflation" violently affecting the bond market in opposite directions. The stock market is much better after the tariff pause, the most drastic policy risks have passed, and the signals that follow, whether "stagnation" or "inflation", are good as long as they are relatively mild. Looking to the future of U.S. stocks, as prices are transmitted and the "period of unconventional stagflation" is gradually opening, U.S. stocks may start to come under some pressure after a sharp rally. By the end of this phase, when the Fed begins to have the confidence to cut interest rates, it is expected that US equities will enter a more favorable period. At the same time, recession risks need to be carefully assessed.
How much luck does Powell have left?
After 50 years, the couples in "Love in the Time of Cholera" are reunited (Chinese novelists are much more benevolent, usually ten years, at most twenty years). For the Fed, it will probably not fully achieve its target of reducing inflation to 2% until 2027, six years after the beginning of 2021. Six years is a long time for a policy cycle or a Fed chairman's tenure, about 50 years. The difference is that the protagonist in cholera has been "victorious", while Powell is still struggling to explore.
Powell will step down in May 2026, and he is fortunate to have experienced a magnificence comparable to that of Greenspan and Bernanke, and richer than the two legends of his predecessors, in just seven years, Powell has experienced a COVID-19 economic shutdown, a QE larger than the 2009-2015 period, a high inflation not seen in 40 years, an epic, almost perfect soft landing, and two fierce trade wars. He's already a celebrity, and at the Chicago Fed's staff meeting in April, where everyone from economists to janitors was invited, people asked him about his daily work habits and hobbies. If the U.S. economy can avoid recession again when he leaves office next year, Powell's luck will be really good, and he will have reason to read "Love in the Time of Cholera."
The content is for reference only, not a solicitation or offer. No investment, tax, or legal advice provided. See Disclaimer for more risks disclosure.
Tariffs, Inflation, and The Federal Reserve (FED): How much luck does Powell have left?
Author: Chen Daotian
Since March 2021, when inflation began to significantly exceed the target of 2%, more than four years have passed, and the Federal Reserve has not brought the inflation rate back to 2%. Currently, Trump's tariff war is expected to bring new price-raising pressures, and the tax reduction plan may provide additional economic stimulus. High inflation is likely to enter its fifth year, whereas the well-known stagflation of the 1970s lasted 'only' ten years. The Federal Reserve's persistent pursuit of the 2% inflation target is long and arduous, reminiscent of Gabriel Garcia Marquez's 'Love in the Time of Cholera.'
Tariffs and Prices: Where have they risen to?
After the "suspension" of tariffs on April 9 and May 12, negotiations between the United States and its major trading partners, the EU, China, and Japan, have not yet yielded results. However, with nearly two months of more complete data on the newly imposed tariffs that are already in effect, we can roughly estimate the impact of the tariffs on prices.
According to the Bipartisan Policy Center, a U.S. think tank, the cumulative total tariffs collected by U.S. Customs for the year as of March 22, 2025 will be $26.5 billion, and by May 22, 2025, the above figure will become $67.3 billion; The figures for the same period in 2024 are $17.7 billion and $33 billion, respectively. The tariffs imposed between March 22 and May 22, 2025, will be $40.8 billion, $26 billion higher than the same period in 2024. The total value of U.S. imports in these two months is about $640 billion, and if the tariff burden is borne by U.S. buyers and is added to the final sales price, the price increase of imported goods should be about 4% (4 the timing of the implementation of the new tariffs in the month is more complete, the tax rate is higher, and the proportion of the price increase should be larger, about 3%). In the total household consumption of the United States, imported consumer goods are about 1.7 trillion yuan, accounting for 8.5%, so tariffs should push up the CPI in April by about 0.3% month-on-month, considering the original trend level, the April CPI should be 0.5% month-on-month.
However, the CPI data released in April is far from that. The CPI growth rate in April was 2.3% year-on-year and 0.2% month-on-month, both at low levels in recent months. Some products with a high proportion of imports, such as clothing and toys, had zero price changes month-on-month, communication electronics were almost flat month-on-month, and medical supplies rose 0.4% month-on-month. There can be several explanations for the above contradictions, one is that imports and inventory accumulation, so the price will not rise for the time being, but it will rise later; Another possibility is that foreign exporters bear the lion's share of the tariff burden, so U.S. domestic retail prices don't have to rise much. These explanations will take time to verify, but in either case, we can analyze a medium- to long-term economic "steady state" after tariffs are imposed.
Tariffs and "Double Reduction": A Long-term Analysis
In a long-term open economy, reducing the fiscal deficit will increase overall savings. The excess savings of a country can be used for domestic investment or for foreign investment. One way to increase foreign investment is to export more, "earn more money from foreigners," and hold more foreign currency assets, which is also reflected in trade as a reduction in the trade deficit (or an expansion of the trade surplus). As net exports increase, the fiscal deficit needs to decrease to maintain output stability. This "dual reduction" is what the United States urgently needs at present.
There are several very different ways to reduce the trade deficit, for example, through the depreciation of the dollar or through the imposition of import duties. The depreciation of the dollar reduces the trade deficit by making U.S. goods cheaper (relative to foreign goods) and boosting external demand. Tariffs, on the other hand, reduce U.S. exports (because tariffs will increase the value of the dollar), but also reduce U.S. imports (imports become more expensive with taxes), and the trade surplus widens because imports fall even more. In other words, the United States, as a trade deficit country, has become more closed through tariff barriers, and the purchasing power of the United States has shifted more to its domestic products, which will lead to an increase in domestic demand in the United States, thereby reducing the trade deficit (the trade deficit of a fully closed economy will be zero).
As I have analyzed in a previous article in this magazine, part of the tariffs are borne by domestic residents, which is equivalent to a forced price increase to subsidize local products (it needs to be remembered that price increases can incentivize local production); Part of it was borne by overseas exporters, who were forced to lower the price of their exports (earning fewer dollars for the same exports), amounting to a transfer payment to the U.S. government. Suppose that the U.S. trade deficit and fiscal deficit were both $900 billion before the tariffs were imposed; After the tariff is imposed, it is assumed that the tariff revenue will increase by 400 billion, half of which will be borne by the United States domestically, and the other half will be borne by foreign exporters at a reduced price (for the sake of simplicity, changes in the dollar exchange rate are not taken into account here); Suppose tariffs cause the trade deficit to fall by 200 billion.
In order to keep aggregate demand unchanged, the decline in the trade deficit of 200 billion yuan (expansionary) needs to match the decline of the fiscal deficit of 200 billion dollars (contractionary), and the 200 billion in tariffs levied by the country is the tightening of aggregate demand, which is exactly matched by the decline in the trade deficit, so this part of the tariff revenue does not need to be spent again (so as to achieve the effect of tightening demand), and can be used to redeem the existing debt. The other $200 billion in tariffs (equivalent to international transfers) will not have a contractionary effect on aggregate US demand, so they should all be used to reduce existing debt. In this example, the trade deficit has fallen, but the fiscal deficit can fall even more, while the macroeconomy remains at full employment. The significance of the conclusion that the fiscal deficit may have fallen more than the trade deficit cannot be ignored, and according to the author's reading, this analysis is not currently considered by the mainstream view on Wall Street.
The long-term outlook looks promising, but the specific path from the current "short term" to the aforementioned "long term" requires more analysis.
Short-term "unconventional" stagflation
In the early stages of tariff implementation, the rise in the price of imported goods will lead to a decline in the total supply of the United States, which means that the hedge between inflation and unemployment has deteriorated. With the same unemployment rate, the inflation rate will be higher, and the more academic term is the upward movement of the Phillips curve. Generally speaking, the movement of the Phillips curve is caused by inflation expectations, imagine that people have a rough consensus about the future inflation rate, and then set product prices and wages based on this. However, the change in supply brought about by tariffs is completely different, it is caused by actual price increases, and this increase is due to tariffs, as if the price increase was forced by executive order. This small difference makes a big difference in the conclusion.
Higher inflation expectations lead to a contraction in supply, but does not affect aggregate demand. The supply crunch caused by tariffs, on the other hand, will automatically tighten monetary conditions due to the real rise in prices, which will lead to higher real interest rates, while higher interest rates will dampen aggregate demand in the short term (and uncertainty will also affect investment), which will increase the probability of a recession. As mentioned above, tariffs "withhold" domestic demand to promote domestic demand, but if the deterrent effect of rising prices is greater in the short term, then the market will be worried about a recession, which can explain the market decline from February to April to a considerable extent.
Unlike loose monetary policy, the price increases caused by tariffs are passive and are the result of actual taxation leading to passive price increases by businesses. Once the price transmission is fully completed, the price increases will also come to an end. It is hard to imagine that during periods of weak demand (even though prices are rising), the market will form higher inflation expectations. Therefore, tariff-induced stagflation is a new phenomenon, and different from the "conventional" stagflation that people are familiar with in history; it is likely to be temporary.
"The Peak and Rate Cuts of "Unconventional" Stagnation
The process of rising prices due to tariffs was completed at a time when monetary policy was at its tightest, as prices were at their highest and the Fed kept interest rates steady in order to stabilize inflation expectations, which was probably the "darkest hour" for the economy. However, the worst time for price increases is also when the tariff shock is about to exhaust, and the timing of interest rate cuts will come with it. Interest rate cuts will stimulate aggregate demand, and international capital outflows from lower interest rates will also benefit exports. If fiscal policy is tightened at this time, it will be the beginning of a "double decline" in the economy, thus moving towards the aforementioned long-term goals.
The Fed's March economic outlook predicts that inflation will not return to 2% until 2027, but this forecast comes at a time when "reciprocal tariffs" and tax cuts have not yet been introduced. In a speech in Chicago in April, Powell expressed serious concerns about tariffs, saying that both inflation and the labor market were under pressure, triggering a plunge in the stock market on the same day. This provoked extreme displeasure from Trump, who demanded that the Fed cut interest rates and claimed that he had the right to remove Powell. At a press conference after the May Fed meeting, Powell once again highlighted the twin risks of rising inflation and a weaker labor market. The high level of uncertainty has led the Fed to adopt a "wait and see" strategy.
In contrast to the "dilemma" attitude of most Fed governors, Waller expressed a clearer view in a recent interview, arguing that the Fed should be brave enough to admit that the inflation caused by tariffs is transitory, and that it should cut interest rates decisively if there are signs of weakness in the labor market, which is close to the "unconventional stagflation" stance of the previous author. In its May policy statement, the Fed still viewed the labor market as strong, but some indicators have hinted at concerns, with the recent ratio of job openings to unemployed in March approaching 1, which is already below the pre-pandemic consensus of normal (1.2). Another factor that should not be ignored is that the demand for services and goods is substituted for each other, and if the price of goods increases, then the demand may shift more to services, so the overall price increase will not be so large. In addition, lower real incomes due to higher commodity prices will also contribute to a slower increase in service prices.
The current policy interest rate is contractionary, and there should be little doubt about this. Inflation will eventually slow down, but the timing is full of uncertainty. The short-term path analyzed in this article includes two phases: "unconventional stagflation" and "interest rate cuts." However, the progress of trade negotiations and the final scale of fiscal tax cuts will bring more variables. A 2% inflation target is very appealing, but the Federal Reserve's pursuit of it is extremely challenging, much like the "Love in the Time of Cholera" in the writings of Márquez.
The reaction of US stocks and US bonds
In the days following Trump's announcement of reciprocal tariffs from mid-February to early April this year, the ten-year interest rates and US stocks showed good synchrony. The market was concerned about the economic recession caused by tariffs, and thus when US Treasury yields fell, the stock market also tended to decline.
There was an abrupt change in the situation between April 7 and April 9, with the 10-year Treasury rate rising 33 basis points in three days, financial markets showing signs of panic, Treasuries no longer being considered safe, and demand for cash expanding sharply. This extreme anomaly can only occur during times of extreme panic, such as the extreme panic over the coronavirus pandemic that caused the 10-year Treasury rate to rise sharply from 0.54% to 1.18% between March 9 and 18, 2020. The three-day plunge in stocks and bonds crushed Trump's confidence in the tariff plan, and on Wednesday afternoon, April 9, the White House hastily announced a tariff pause.
On April 11, the Treasury rate rose to a stage high of 4.48%, then fell rapidly to 4.17%, and then rose again to 4.58% on May 21, which is roughly a V-shape. This extreme volatility reflects a high degree of macroeconomic uncertainty, with different signals of "stagnation" and "inflation" violently affecting the bond market in opposite directions. The stock market is much better after the tariff pause, the most drastic policy risks have passed, and the signals that follow, whether "stagnation" or "inflation", are good as long as they are relatively mild. Looking to the future of U.S. stocks, as prices are transmitted and the "period of unconventional stagflation" is gradually opening, U.S. stocks may start to come under some pressure after a sharp rally. By the end of this phase, when the Fed begins to have the confidence to cut interest rates, it is expected that US equities will enter a more favorable period. At the same time, recession risks need to be carefully assessed.
How much luck does Powell have left?
After 50 years, the couples in "Love in the Time of Cholera" are reunited (Chinese novelists are much more benevolent, usually ten years, at most twenty years). For the Fed, it will probably not fully achieve its target of reducing inflation to 2% until 2027, six years after the beginning of 2021. Six years is a long time for a policy cycle or a Fed chairman's tenure, about 50 years. The difference is that the protagonist in cholera has been "victorious", while Powell is still struggling to explore.
Powell will step down in May 2026, and he is fortunate to have experienced a magnificence comparable to that of Greenspan and Bernanke, and richer than the two legends of his predecessors, in just seven years, Powell has experienced a COVID-19 economic shutdown, a QE larger than the 2009-2015 period, a high inflation not seen in 40 years, an epic, almost perfect soft landing, and two fierce trade wars. He's already a celebrity, and at the Chicago Fed's staff meeting in April, where everyone from economists to janitors was invited, people asked him about his daily work habits and hobbies. If the U.S. economy can avoid recession again when he leaves office next year, Powell's luck will be really good, and he will have reason to read "Love in the Time of Cholera."