My latest column is about how inflation is fading as both an economic and a political issue — which is good news for Kamala Harris and bad news for Donald Trump. Yet it remains quite possible that Trump will win. And if he does, inflation may become a major problem again.
Economic forecasters surveyed by The Wall Street Journal last month generally predicted that inflation would be higher if Trump won than if President Joe Biden (still the Democratic nominee at that point) won. As you might guess, I agree. In fact, I believe that most analysts are still understating just how inflationary a second Trump term might be.
Why? Because I don’t think even most economists fully appreciate the possible interactions between Trump’s love of tariffs, his desire to politicize the Fed and his expressed desire for a weaker dollar.
Start with tariffs. Trump has been saying for a while that he wants to put a “ring around the collar” of the U.S. economy, with 10% tariffs on everyone and a much higher rate on China. Lately he’s been going bigger, suggesting a 20% rate. I wouldn’t put much weight on these numbers, which he’s surely pulling out of thin air. But for what it’s worth, tariffs at the rates Trump is suggesting would be seriously inflationary, raising prices enough to reduce the typical family’s purchasing power by 4% according to one estimate.
In case you’re wondering, this estimate also shows the impact of Trump’s plans to extend his 2017 tax cut, which would do little to offset the effects of the tariffs for most people but would produce a net gain for, you guessed it, the top 1%.
But rather than take Trump’s made-up numbers seriously, it probably makes more sense to ask what he would be trying to do. We know that Trump has a mercantilist view of trade, in which we win if we run a trade surplus, lose if we run a trade deficit. So the goal of his tariffs would be to eliminate the U.S. trade deficit.
And a 20% tariff rate wouldn’t accomplish that goal. In fact, it would probably do little to reduce trade deficits at all.
Partly that’s because U.S. businesses rely on a lot of imported parts and materials, and an across-the-board tariff would mostly just raise their costs. More fundamentally, tariffs would tend to raise the foreign exchange value of the dollar, making our exporters less competitive.
The impossible trinity
Why would this happen? The balance of payments always balances — the total inflow of money into America must equal the total outflow. In particular (leaving aside some technical issues involving investment income), it must be true that: Trade deficit = net inflows of capital.
So unless we reduce the amount of foreign capital flowing into the United States — the amount that foreign governments, companies and individuals are investing here — we can’t reduce the trade deficit. The way that normally plays out is that if we reduce imports, that change is offset by a fall in exports. Squeezing any one piece of the trade deficit is like pushing on a balloon: It just expands someplace else. And the mechanism through which that happens is typically a stronger dollar.
So imagine a Trump administration that imposes tariffs to eliminate the trade deficit, then finds that it didn’t work. You might think that this would lead Trump and his advisers to rethink their policy ideas; that is, you might think that if you’ve spent the past seven years in a Trappist monastery or otherwise under some sort of metaphorical rock. It’s much more likely that Trump would dig in and push tariffs even higher.
Furthermore, Trump has been saying that he wants a weaker dollar. He would presumably be deeply frustrated if the dollar grew stronger instead as a result of his tariffs. So he would demand that something be done.
But what can be done? There’s another fundamental principle in international economics known as the impossible trinity. It says that so long as capital is free to move across borders, you can’t make a distinction between exchange rate policy and monetary policy. In this case, it means that the only way to push the dollar down would be for the Federal Reserve to push down interest rates, which would be inflationary if the economy is near full employment.
Would the Fed cooperate? It’s supposed to be independent. But Trump wants to end that independence.
The Trump economy
So here’s my Trumpflation story: After being returned to power, Trump, with his mercantilist views, tries to eliminate trade deficits with tariffs. When this fails, in part because the value of the dollar has gone up, he raises tariffs even higher, while leaning on the Fed to cut interest rates to push the dollar back down.
All of this would be seriously inflationary. So, by the way, would mass deportation of a significant part of the U.S. workforce.
How would Trump deal with inflation? We don’t know, but foreign authoritarian leaders, whom Trump admires, often respond to economic difficulties by embracing crackpot theories peddled by people telling them what they want to hear. After all, Trump is insisting that tariffs don’t raise consumer prices, a view that essentially no mainstream economists support.
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How high might Trump drive inflation? Well, in recent years President Tayyip Erdogan of Turkey made a point of rejecting orthodox economics, driving inflation to 85% before finally giving in and accepting some mainstream advice. It would take a lot to get America, which starts from a strong position, into that much trouble, but I don’t believe that most analysts are fully realizing just how bad Trumpflation might get.
Of course, we may never find out. Polls have moved against Trump since Harris replaced Biden as the Democratic nominee. And to be honest, inflation is not at the top of the list of things that would worry me if Trump got back into power.
Still, Trumpflation is one threat — and a bigger one than most analysts seem to realize.
Paul Krugman is a New York Times columnist.
