One of the main experts on tariffs and their impact on the economy will visit Chile next week, as a speaker at the Annual Conference of the Central Bank (BC), which will take place on Thursday and Friday.
Guido Lorenzoni, doctor in Economics from MIT and current academic at the University of Chicago, will present the paper “Tariffs, intertemporal trade and trade deficits” at the BC meeting, which will later be commented by Iván Werning, academic at MIT.
The Italian economist and former advisor to the Prime Minister of that country, Mario Draghi, analyzes in an interview with Pulso the effects of tariffs on the monetary policy of the Federal Reserve (Fed), the impact on the economy and what the rest of the countries should do in a scenario in which tariffs are imposed unilaterally.
What is the effect of tariffs on monetary policy?
-First of all, we must distinguish between the central bank of the country that imposes the tariffs and the central bank of the countries that are affected by them. As the US is raising tariffs, there is a view according to which the tariffs had the main effect of redirecting spending. Tariffs would cause American consumers to buy fewer foreign products and shift toward domestic products. Under that view, tariffs are primarily a kind of positive demand shock, so the effect would be expansionary for the domestic economy. In that scenario, it is quite easy for the central bank to respond, because the situation just needs to cool down a little. But broader research has changed this view. Tariffs are also important because they affect what we call the supply side of the economy, and there is no right answer there. We cause inflation to rise and, at the same time, we contract the economy. Then you have to decide which battle to fight.
Considering, of course, that the Fed has a dual mandate, on inflation and activity…
-Yes, especially if the central bank has an explicit dual mandate.
Why do tariffs have this effect on supply?
-Many of the imports of the US economy are, in reality, imports of intermediate goods, inputs for the production of other things. And if we think about it that way, then a tariff is like a shock to the price of these imported inputs. And so, companies that use these inputs as raw materials will have to pass it on to consumers. And that is an inflationary effect. But at the same time, those same companies will become less profitable. Therefore, there will be some contraction in the profits of hiring new workers or creating new jobs. And that will have a contraction effect on the supply side. In that sense, it is more like a standard supply crisis.
If tariffs produce these opposing forces, the question is which force will prevail…
-Yes, and in addition to that, many other things are also happening in the economy.
Was there an overreaction to the effect Trump’s announced tariffs would have when they were announced?
-The financial markets were very scared and not necessarily because of the tariffs specifically, but because of economic policy in general. If you think that this administration is willing to take very extreme measures in terms of economic policy, then you start to worry about many other issues. So I think there was a scary moment where people thought, “Okay, this is really an unprecedented change in the way we do it in the US, a big change in the way we treat economic partnerships with other countries.” I think that created a lot of fear in the financial markets. But after a while, they decided it wasn’t that big of a deal.
And how does it look now?
-Perhaps the concern is the opposite. We are at a time when perhaps financial markets are underestimating the damage that that type of fragmentation of global trade can cause to the US economy itself.
How do you evaluate the role of the Fed, which was cautious at first, but has already reduced the rate twice in recent months?
-They are more concerned about employment at this time than about tariffs. They see some slowdown.
And may they be worried about President Trump’s pressure on the institution?
-I think it is a reasonable concern. It’s not just about the way the legal framework works. It’s also about unwritten rules about how the president lets the Fed chair do his job. Some sort of erosion of those rules is not good. But it also depends on how the financial markets react. If the financial markets, at any point, seemed a little worried about the independence of the Federal Reserve, they decided to move on and worry about other things.
One of the reasons President Trump said he wanted to implement these tariffs was to reduce the US trade deficit. In your opinion, is this an effective way to achieve this?
-This is going to be the topic I am going to talk about at the Central Bank of Chile conference. Over the last 50 years, trade barriers have been decreasing. Therefore, we don’t have much evidence. But the conventional wisdom is that tariffs don’t have much of an effect on the trade balance and current account. Therefore, the change in tariffs does affect trade, but trade on both sides. The conventional wisdom is that when tariffs are imposed, imports are reduced, but exports are also reduced. Therefore, both are reduced. And it is not obvious that the difference is going to change much. So there is less trade, but it is not that the deficit decreases. Fewer goods and services are imported, but fewer goods and services are also exported. The fact that the US has a trade deficit reflects that, in general, if you add up American consumers, businesses and the government, there is a greater desire to spend than other countries. So, overall, that makes the US a net borrower. That’s why we have a deficit. And those forces don’t change much when tariffs change.
But do you see an effect on the deficit?
-Tariffs will have a reduced effect on the trade balance.
And it would help to reduce the trade deficit, right?
-That would certainly help. It’s something the US could do right away. It is an excellent example.
What could emerging markets, like ours, do in this high tariff scenario?
-The best thing is to preserve the multilateral system of rules with low trade barriers. Europe and South America should reinforce any trade agreement that involves being stronger and more open. But, the difficult question is what to do with the US.
Exact. Should tough measures be taken, or should we allow what the US is doing and reach agreements?
-In this case, the correct response would have been rather a retaliation and a forceful retaliation. Because, after all, the global trading system is held together by the threat of radiation. Because if an economy imposes tariffs, that economy can gain, since it can improve its terms of trade. It can ultimately make your goods and services more expensive in the global economy. So we need a system of sanctions. But if we all do it, it is a negative thing. We all lose. That is why we want to preserve a free trade system. But for that we must have a system in which the agent who fails to comply is punished. Because otherwise there is no control.
Has your perspective on this changed?
-At first, I thought it was a good idea not to close trade with the US, not to try to retaliate, but I think I was wrong. I think the correct answer is that we must retaliate. It is the way to prevent other countries from being tempted to do what Trump is doing. So I think China has played its cards better.
But China has enough power to do it…
-I don’t think it was obvious where China’s power was at the beginning. And I think they just thought a lot about ‘where can we do a lot of damage to the American economy?’ And then you hurt them where it hurts most. And I think Europe should have done the same.
