Is Trump Right About the Fed Getting It Wrong?

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0:42This is Matt Rogers from Las Culture East. That's with Matt Rogers and Bowen Yang. This is Bowen Yang from Las Culture East. That's with Matt Rogers and Bowen Yang. You know when people try on new food and suddenly it's like, wait. That's the reaction a lot of people are having when they first try Kewpie mayo. It's the one with the red cap and the little baby on the bottle. You've probably seen it in the grocery store before. And if you've ever just walked past it, some people would say that's a huge mistake. Because this mayo is different. Most mayonnaise uses whole eggs. Kewpie only uses egg yolks, which gives it this rich umami flavor.

1:15It's smoother, deeper, and almost buttery. Once people try it, they start putting it on everything. Egg sandwiches, fries, burgers. Some fans even swear by dipping pizza crust in it.

1:25Stephanie Flanders:And once you notice it, you start seeing it everywhere. Chefs use it. Restaurants use it. People who really care about flavor use it. Never tried it? Grab the bottle with the red cap next time you're at the store. Put it on just about anything. Then you'll understand. QP, the original Japanese mayonnaise. If you like YouTube, you'll love YouTube Premium. Hi, I'm Sean Evans from Hot Ones, and I want to tell you about YouTube Premium. It has offline downloads, so you can watch without Wi-Fi. Background play, so you can lock your phone, and it still plays, baby. Oh, and it is completely ad-free. Yes, I said it, ad-free.

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2:13Bloomberg Audio Studios, podcasts, radio, news. If you just look at the basic data and don't look at the forecast, you would say that we would have continued cutting. The difference, of course, is at this time, all forecasters are expecting pretty soon that some significant inflation will show up from tariffs. And, you know, we can't just ignore that.

2:44Stephanie Flanders:I'm Stephanie Flanders, Head of Government and Economics at Bloomberg, and welcome to Trumponomics, the podcast that looks at the economic world of Donald Trump, how he's already shaped the global economy, and what on earth is going to happen next. And this week, we're digging into whether the Federal Reserve has been wrong in its assumptions about the economic impact of Donald Trump's tariffs. The entire White House wants Federal Reserve Chair Jay Powell to lower interest rates. Commerce Secretary Howard Lutnick slammed him, saying he's afraid of his own shadow for keeping interest rates so high.

3:16Stephanie Flanders:Treasury Secretary Scott Besant has also repeatedly pointed to the markets here, arguing that they've sent a clear signal that a cut is overdue. And of course, we've heard the President himself nickname the Fed Chair many times, Too Late Powell, calling him a fool, not a smart person for his refusal to cut rates. So we're asking a simple question. Do they all have a point? I mean, maybe not about the Jay Powell being smart part, but have Chairman Powell and the Fed's Interest Rate Setting Committee, the FOMC, been too slow to cut rates? And the answer to that, it turns out, depends on whether they're correctly judging the likely impact of the President's tariffs on inflation.

3:57Stephanie Flanders:Because, by his own admission, earlier in the year, Chair Powell was expecting to have lowered interest rates by now. And the main reason that changed was the so-called Liberation Day, when President Trump unveiled his sweeping new tariff policy. At that point, Powell and nearly all of his Fed colleagues decided to err on the side of caution, waiting to see if the trade conflicts and tariffs increased inflation in the US. But were they wrong then? And are they wrong today? Well, we have two excellent guests to discuss that. First, we've invited back Oren Cass to Trumponomics. He's the founder and chief economist of American Compass, author of The Once and Future Worker, a vision for the renewal of work in America.

4:41Stephanie Flanders:He's also served as a domestic policy director for Governor Mitt Romney's 2012 presidential campaign and has been a senior fellow at the Manhattan Institute for many years. Oren, I'm really glad to have you back on Trumponomics. Oh, thank you. This is such a fascinating topic. I'm excited to dig in. That's a very good start. And back again, we have Anna Wong, chief U.S. economist for Bloomberg Economics. And before that, she worked at the Fed, US Treasury and White House Council of Economic Advisors during Donald Trump's first term. Anna, great to have you back. Happy to be back.

5:16Stephanie Flanders:So, Oren, there's so many things I could talk to you about. You're relatively distinctive in the current sea of commentary on the administration in being both supportive of the president's basic agenda, but very rigorous in thinking about the best way to make it a reality. and you certainly don't follow the president slavishly. But one column you wrote, I did want to talk to you about, you were really agreeing with Donald Trump in suggesting that the Fed had just got the impact of tariffs on inflation completely wrong. So talk us through the reason you think the Fed has been wrong to talk about, and indeed lots of economists, to talk about tariffs being inflationary.

5:52Well, I think the interesting thing that I've discovered as I get more involved in this fight is that economists actually, for the most part, if pressed on this question, will admit that tariffs are not inflationary. The definition of inflation, certainly as it is relevant to a central bank setting monetary policy, concerns an ongoing increase in the overall price level. If you choose a specific policy that by design makes a one-time change in the price of certain things, that is not inflation in a sense that you would want a central bank to worry about or that you would ever try to address by raising interest rates or keeping interest rates higher.

6:35As far as I can tell, you know, when economists are pushed beyond their talking points of just hating tariffs and wanting to attack them any way they can, they will admit this is not what inflation means in the way that economists are talking about it for purposes of monetary policy. And so, look, if the Fed wants to say, given current economic conditions broadly, we think rates are at the current level, they could say that. The problem is that you have Jay Powell out there explicitly saying, I would say we should be cutting except for the fact that we expect for inflation from tariffs. And that is simply an indefensible position to be adopting.

7:14Stephanie Flanders:Why do you think economists have been so quick to talk about tariffs as inflationary? Well, because I think economists and again, not not hashtag not all economists, but most economists have have shown over the last couple of years to have a very deep ideological opposition to tariffs that has quite toxically interfered with their ability to engage in in public debates on the issue. I think there are all sorts of perfectly valid criticisms to make of tariffs, but economists are determined, it seems, to win the political fight over them. And over the last few years, obviously, inflation has become a very salient political concern.

7:58And so you could see, you know, as Trump was gaining steam last year, you just saw them start to jump up and lob this talking point in, even though you could even go back to Trump's first term and look at not to the same scale as what's going on right now. But Trump imposed very significant tariffs, particularly on China. It's very hard to find back then a lot of people focusing on on inflation related critiques. It's also very hard to find any inflation in the data from that period. But this became a political point to score. And I think, unfortunately, a lot of economists have decided that the ends justify the means.

8:39Stephanie Flanders:So just to be clear, you think that prices will go up or the price level will go up in response to the tariffs, but nothing else will happen after that. And there won't be any kind of increase in wages as people try and sort of catch up with the higher cost of living represented by that higher price level or anything else that could be inflationary. Well, I would love to see an increase of wages because we see investments that lead to rising productivity. But with respect to other macroeconomic effects like you just mentioned, I really do think the right way to analyze tariffs is the way that we analyze other taxes.

9:17If somebody proposed the addition of a VAT, economists would not warn that it is inflationary. If anything, they would say it's probably deflationary because we would potentially be raising additional revenue, and that could go toward addressing the deficit. I think another very good example is carbon taxes. Without saying anything about the merits of carbon taxes, it's safe to say that the many economists that aggressively support carbon taxes as efficient and the ultimate in wise neoliberal policy do not spend a lot of time worrying that that is going to set off some sort of inflationary spiral.

9:54What you are getting is a change in relative prices. And of course, you also have the problem that economists are talking out of both sides of their mouth because what they really say is that they think tariffs are going to slow the economy down. If they actually took seriously their own view of the effects that tariffs would have, should probably lean toward looser monetary policy, if anything. This is not an argument about the independence of the Fed. This is not an argument that prices are not going to rise in some cases, that consumers aren't going to feel the effects. That all is true. And in fact, that is the point of tariffs.

10:31But if what you're asking is how a central bank and how monetary policy should address them, it seems to have gotten very unproductively entangled in a lot of this political rhetoric, as opposed to what it is that economists themselves are otherwise arguing in almost every case.

10:48Stephanie Flanders:Now, Anna, I know there's lots of different pieces of this, so we'll try and sort of, you know, unpack different elements. But as our chief US economist, you're obviously trying, as far as any of us is humanly able, to strip ideological concerns and politics out of your analysis. You're mainly looking day to day at what you're actually seeing in the economy and then thinking how that feeds through into your forecasts and your analysis. But if you're stepping back from all of that, a few months ago, would you have said these tariffs are going to be inflationary? Yeah, a few months ago, I had penciled in a 0.3 percentage point increase in

11:24Anna Wong:the core PCE from all the tariffs, and I still maintain that forecast. And I also had written a lot about how I think there is a big chunk of the tariffs that would be absorbed through profit margin, and that services, this inflation can offset some of them, given that US at the end of the day, is a service-oriented economy.

11:48Stephanie Flanders:And so what is your response to Oren's argument? Do you think the Fed has overdone the risk of inflation from these tariffs? Because of course, we would expect a short-term increase in prices without necessarily thinking that this is an inflation problem that the central bank needs to respond to. Right.

12:08Anna Wong:The reason why I had that view a couple months ago that there's a possibility that the tariffs would not be as inflationary is because of Fed's own internal models back in 2018. So back in 2018, in one of the FOMC meeting, Fed staff were studying why aren't tariffs as inflationary as they had forecasted.

12:32Stephanie Flanders:The first round of Trump tariffs. Yes.

12:34Anna Wong:And they ran two models. This is a very well-established internal general equilibrium model. And one of them shows that if tariffs were imposed in primarily intermediate goods, which it was back in 2018, 2019, then the inflation would be very short-lived and even deflationary after the first couple of quarters. And then another version of the model says suppose that all the tariffs were on consumption. What happens? It also shows that the tariffs would be a one-off price level shock. In fact, the Fed even ran some versions of the optimal monetary policy of whether to look through this tariff shock versus not looking through.

13:18Anna Wong:And the model would find that raising rates in response to the price increase would not actually reduce inflation any further from the tariffs. So the conclusion is that if inflation expectations are anchored, there is no point in responding to the tariffs. So what's changed in this round, in trade war number two, in the Fed's thinking and respond to tariffs from my observation is, number one, they seem to be not so sure whether that inflation expectations are anchored. So that is the precondition of monetary policy, not looking through these tariff shocks. And second, they seem to be really embracing a new trade literature that use a new type of trade models.

14:09Anna Wong:And those trade models would come to different conclusions than the models that the Fed used in 2018. And the new conclusion is that, in fact, tariffs on intermediate goods would be persistently inflationary due to the impact on productivity. So from where I see it, those two are the key differences, intellectual key differences for why the Fed is responding differently than from the lesson they learned in 2018 and 2019.

14:38Stephanie Flanders:There's an interesting comparison. The importance for the judgment call by the central bank of whether or not they view inflation expectations to be well anchored. Is there a risk because people are already worried about inflation that this so-called one-off increase in prices will actually cause people to demand catch-up wages and a sort of spiral after that and it will become inflationary? Or are they pretty confident going into it that this is just a one-off, that inflation is going to stay low, in which case you probably don't want to do anything? And you had an example, I think in Japan, when they increased VAT, the central bank didn't do anything, allowed the inflation effect to come in and then inflation fell back down and there was no issue with how the central bank had left it because expectations were well anchored.

15:29Stephanie Flanders:Whereas in Turkey, where there was a lot more question mark around the independence of the central bank and the likelihood of further inflation, they had increased taxes, VAT, through the 2000s and that had actually helped to further unanchor inflation expectations. The sort of pre-existing situation in terms of what people are expecting about inflation matters. And I guess coming back to you, Aaron, I mean, is it your view that there was no risk of that kind because inflation expectations coming in this period were basically well anchored? If you are wondering how consumers feel about inflation, then of course, what the central bank does and says is quite endogenous to that question.

16:14So what you can't have, and apparently we do now have, is a set of models that say tariffs are not inflationary, a set of economists who say, oh, but we really don't like tariffs. and therefore we're going to spend years running around shouting that tariffs are inflationary, even though we know that our own models say that they are not, until we persuade consumers that they will be inflationary, at which point we can say, you see, now they will be inflationary and use that as an excuse to impose a monetary policy directly counter to the political choices that people have made supporting an agenda that focuses heavily on accepting a change in the price level to induce higher levels of domestic investment.

16:58And so this is where I just get so frustrated that the sorts of things that I'm talking about are pointed at as like, oh, he doesn't respect central bank independence. I would like nothing more than a competent, honest, independent approach to setting monetary policy. And that is not what we are getting right now. If the Fed had spent the last couple of years accurately communicating, if economists had spent the last couple of years accurately communicating what their own view of tariff effects on price levels would likely be, we could have this conversation. I think it is very hard to stomach a situation where they have created this consumer mentality that they now say that they need to counter with policies that their own models said they should not need to be using.

17:42Stephanie Flanders:So there's a lot of noise about AI, But time's too tight for more promises. So let's talk about results. At IBM, we work with our employees to integrate technology right into the systems they need. Now, a global workforce of 300 ,000 can use AI to fill their HR questions, resolving 94 % of common questions. Not noise. Proof of how we can help companies get smarter by putting AI where it actually pays off, deep in the work that moves the business. Let's create smarter business. IBM. This is Matt Rogers from Las Culturistas with Matt Rogers and Bowen Yang. This is Bowen Yang from Las Culturistas with Matt Rogers and Bowen Yang.

18:19You know when people try a new food and suddenly it's like, okay, hold on, I got a new favorite food. That's the reaction a lot of people are having when they first try Kewpie mayo. Yeah, it's the one with the red cap and the little baby on the bottle. You've probably seen it at the grocery store. And this mayo is different. Most mayonnaise uses whole eggs. Kewpie only uses egg yolks, which gives it this rich umami flavor. It's smoother, deeper, almost buttery. Once people try it, they start putting it on everything. Egg sandwiches, fries, burgers. Chefs use it. Restaurants use it. People who really care about flavor use it.

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19:59Stephanie Flanders:I like the way you describe it. But one could also say that the Fed itself had played a role in unanchoring inflation expectations. You know, we highlighted some of the comments from Lutnik and the president himself at the beginning would say that the Fed had got policy wrong in a very damaging way and had let inflation get out of control. They would say for political reasons, president says it was because he was, Jay Powell was trying to get the Democrats reelected. But putting that to one side, a lot of people would say there had been a policy mistake which had then left a situation where there was a potential unanchoring of expectations that people had begun to expect inflation.

20:44Stephanie Flanders:So I guess the critics can't have it both ways. They can't say they caused a lot of damage by allowing inflation to stay as high as it was for as long as it was. But now they shouldn't be taking that into account and thinking through the longer term impact of tariffs. Well, I guess I would look at that a little bit differently, which is that, yes, I think it is very fair to say that the Fed damaged its credibility by getting this wrong last time. I do not think it helps the Fed's credibility that when one party's administration pursued one set of policies that, frankly, I think most economists would say are very inflationary, like dumping trillions of dollars of additional spending into an arguably overheated economy in ways, you know, long after the economic effects of COVID had passed.

21:39When you look at that and say, well, you know, hey, maybe let's hold off and you get it completely wrong. And then the other party comes in with a set of policies that, in fact, your own models say are not inflationary, but they're policies you don't like. You then take exactly the opposite stance. Again, if we want to characterize the Fed's role as primarily to be the nation's psychologist and stick its finger in the wind, I guess it can justify anything it wants to do. But I think it is badly, and frankly, more so than Donald Trump, endangering its credibility as an independent institution if it takes what are clearly such nakedly political judgments in lieu of actually doing what economic theory and common sense say would be good governance of monetary policy.

22:35Stephanie Flanders:Anna, you spent a formative part of your career as a Fed economist. I suspect that you'll be conflicted in answering this question. But do you think the Fed has been coherent in its approach over the last couple of years, and particularly the arguments it's had with itself and made to the public over the last six months over tariffs?

22:57Anna Wong:Yes, Stephanie, I am conflicted. Because I think The truth is, I think there's a difference between Fed independence and Fed accountability. I wholeheartedly support Fed independence. But on the accountability part, if a public institution demonstrates in the past five years that it had made so many policy mistakes and misjudged forecasts, then it probably is not enough to say that, well, most of the economist profession says this, so we are not alone in making this mistake. And accountability begins with looking deep into the institution to figure out why is it that the Fed with all this very smart economist, and I have to say, Fed economists are the smartest people I've met.