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President Trump has made America protectionist again. With new tariffs imposed on goods imports into the United States, as well as targeted measures for steel, aluminium and cars (among other products), the economic impact of ‘Liberation Day’ could be substantial. Not only are American consumers and firms set to experience sharp price increases, but economies around the world now face a heightened risk of recession. Central banks must be alert to this evolving risk, including further retaliation from China, and must do what they can to mitigate the impact of the tariff shock – all while keeping inflation under control.
In the immediate aftermath of the 2024 Presidential Election, international trade became a key topic of discussion among central banks. This is because tariffs have complex economic effects that monetary policy struggles to offset.
When a country imposes trade barriers such as tariffs, imported goods become more expensive. For households, this means higher consumer prices and reduced purchasing power, leading to lower demand. For companies, higher costs of imported raw materials combine with weaker demand. In countries hit by the tariffs (i.e., those exporting to the tariff-imposing country), the result is often a recession. If tariffs target only specific sectors (like cars, metals or pharmaceuticals), they can still cause significant sectoral and regional imbalances.
The effects on inflation are mixed: while tariffs push consumer prices up, weaker demand can drive producer prices down. In the United States, macroeconomic models show that the demand effect dominates. But in more open economies, rising input costs could prevail.
So, as early as November 2024, central banks feared being caught in a tough spot: tightening policy to fight inflation could hurt companies and increase unemployment, while stimulating the economy might fuel inflation further. In theory, monetary policy can be used to stabilise producer prices: it’s not designed to correct distortions in consumer prices caused by import taxes. But today, central bankers must also grapple with the political significance of the inflation spike seen over the last two years.
In recent weeks, the situation has become even more complex for several reasons. The most important is the scale and unpredictability of US trade policy under the new Trump administration. Tariff announcements ranging from 50% to over 100% took markets and policymakers by surprise. These levels, far beyond recent historical experience, could have much stronger effects than what current models predict. Also, confusion reigns over the real goals and implementation of these measures: they are justified as sources of tax revenue, tools for reindustrialisation, national security strategies, or threats to reduce trade surpluses with the United States. But these objectives often contradict each other.
For example, to raise revenue, tariffs must hit goods with inelastic demand (where higher prices don’t reduce consumption much). To support domestic production (and avoid hurting consumers too much), tariffs should target goods with elastic demand (that can be easily replaced by domestic products). These goals cannot be achieved simultaneously.
As of now, no one knows which countries or sectors will be affected, or when and how severely. This is more than just ‘uncertainty’ – a term that’s overused and often insufficient. What we’re witnessing is a profound break in the international order that governed economics, politics and defence in the decades after WWII. In such a climate, businesses hesitate to invest, and households hold back spending. The result – falling investment and rising savings – points to a strong recessionary push in the coming months, as many analysts agree.
In the very short term, however, we’re seeing opposing forces at play: businesses and consumers are rushing to buy now to beat future price hikes. For example, exports to the United States from many countries have surged in recent weeks, as American companies stockpile goods in anticipation of the price increases.
It’s also worth noting that the Trump administration has promised major tax cuts for businesses and the wealthy. While the credibility of these promises has weakened recently, they haven’t been ruled out. For these (and other) reasons, the US economy still appears resilient, at least in the labour market. This is why the Federal Reserve remains alert on inflation but has not yet launched new monetary stimulus. In other countries, the economic cycle is clearly worsening.
Another serious concern is the instability of government bond markets. In the United States, there is no clear debt-reduction plan, and in Europe, fiscal policy must account for increased defence spending – partly in response to the United States withdrawing its security guarantees for Ukraine. To keep the bond market stable, central banks may need to step in to prevent further financial market disruptions.
On a deeper level, if a full-blown tariff war breaks out in a highly polarised global environment, can central banks carry on as independent institutions, focused on macroeconomic stability as defined today? Under what conditions? The debate on how to coordinate fiscal and monetary policy – revived during the Global Financial Crisis and Covid-19 pandemic – remains unresolved, and finding a balanced solution may now be even harder.
Author: Giancarlo Corsetti