MNI INTERVIEW: Fed Will Face ‘Tough Calls’ In H2-Holtz-Eakin

Federal Reserve officials will face a difficult choice on interest rates later this year as a significant reprieve on tariffs remains unlikely, so inflation will rise at the same time as economic growth falters, former White House economist Douglas Holtz-Eakin told MNI. 

Wall Street is too sanguine about the notion that the worst is over on the trade war front simply because U.S. President Donald Trump has temporarily paused some tariffs while facing legal setbacks on others, Holtz-Eakin said in an interview

“The notion that we’ll end the year with no tariffs strikes me as naive,” he said. “There are other authorities he has, section 232, section 301, that that he's already used could be used more extensively. There are other routes do the kinds of things he wants to do and I would expect that to happen.”

“They have the luxury of waiting for another meeting but after that they start having some real tough calls,” he said. 

NO REPRIEVE

Holtz-Eakin, president of the American Action Forum, said the uncertainty and policy volatility surrounding tariffs had already dented GDP growth to the tune of a full percentage point. The hit could be worse if larger tariffs now on hold are reimposed, he said. 

“If we got back to the level of tariffs on Liberation Day, I think the economy deteriorates substantially in the second half, and they cut to save the employment mandate,” he said. “They were suspended for 90 days. This president would do it. The courts might stop him.”

At the same time, inflation could rise as high as 4-4.5% in coming months, which would put the Fed in a serious bind, he said.

In terms of timing, he sees the jump in inflation happening in the next couple of months while the hit to growth will show up in the third quarter and beyond. Meanwhile, the on-again off-again nature of the policies will make it hard to get a clean read on the data. 

“There's no way they'll move preemptively to cut, since the inflation will hit first. And in the second half of this year, I think the Fed earns its money, because it's going to be tough,” Holtz-Eakin said. (See MNI POLICY: Fed Cut Impetus Fades Alongside Recession Fears)

“The Fed correctly recognizes that this is not a genuinely inflation event, it's a price level event. But the question is whether the public will appreciate that nuance or not exactly, and we've already seen Michigan-survey-style inflation expectations bounce way up.”

FISCAL PRESSURES

Holtz-Eakin, also former director of the Congressional Budget Office, said the recent spike in long-term Treasury yields is related to a deteriorating fiscal outlook that has recently become more salient for global investors.

“The U.S. fiscal trajectory is unsustainable, so that's not news. The Moody's downgrade was important in that the previous downgrades explicitly cited political difficulty in managing our finances as a primary concern,” he said. 

“Moody's didn't say a word about that. It just said, you have too much debt, you have too much interest. So that means that the problem is the problem, not the process. That's a significant change. And the reconciliation bill, as it came out of the House, doesn't improve it at all, it makes it worse.”