With the presidential election less than six months away and Donald Trump leading in key swing states, investors and the public are fixated on high inflation.
The prevalent view is that inflation was low during Trump’s presidency, and Biden’s economic policies are to blame for the substantial price increases during the past three years. Consequently, many people presume inflation will be lower if Trump wins the presidency than if Biden is reelected.
This assessment may not pan out, however, for two reasons.
One consideration is that global inflation was much lower during Trump’s presidency than today. For example, from 2017 to 2020, consumer price inflation averaged only 1.5 percent per annum in the advanced economies (versus 1.8 percent in the U.S.) according to International Monetary Fund data.
Moreover, both the Bank of Japan and the European Central Bank were concerned about the threat of price deflation then, and they pursued negative interest-rate policies, while U.S. interest rates were low but positive.
During the fallout from the COVID-19 pandemic, inflation subsequently spiked in the U.S. and abroad due to supply chain shortages and policies to counter higher unemployment. While the pace eased considerably last year, U.S. inflation has proved sticky of late and is running at about 3-3.5 percent. If it stays elevated and Trump wins the election, he would have to contend with inflation that is above the Fed’s 2 percent target for the first time.
The second consideration is that the economic policies Trump and his advisors are considering could exacerbate inflation.
In a recent Project Syndicate commentary, Maurice Obstfeld, former chief economist of the IMF, contends that several policy proposals that Trump’s advisors have floated would revive 1970s-style inflation. One proposal would increase presidential influence over Fed interest-rate decisions and rulemaking, while another calls for weakening the U.S. dollar to reduce the U.S. trade deficit.
The proposal relating to the Fed’s independence was cited in a Wall Street Journal story. It claimed a group of Trump allies produced a secret document that outlined a way for Trump to be consulted on interest rate decisions while Fed regulations would be subject to White House review.
Although the story has not been corroborated, Trump has long favored low-interest rate policies to spur the economy. During his presidency, he criticized the Fed openly for not pursuing negative interest rate policies as Japan and the European Union had done. However, Trump stopped short of challenging the independence of the Fed in order not to roil financial markets.
The proposal on international trade and the dollar has been linked to Robert Lighthizer, who served as special trade representative in Trump’s administration and is a potential candidate for Treasury secretary. He was also the architect of the decision to increase tariffs on China and other trading partners that Trump pursued.
More recently, Lighthizer wrote a book that foresees taking an even bolder stance in which the goal would be to eliminate global trade imbalances altogether. He would do so by devaluing the dollar and increasing tariffs across the board.
Obstfeld counters that with the U.S. economy already at full employment and the Fed seeking to contain inflation, policies designed to weaken the dollar and/or to increase tariffs would drive up import prices and boost inflation. They would also pose a risk to the bond market and stock market in my view.
Nor is massive currency market intervention a viable way to depreciate the dollar. The last attempt to do so was the Plaza Accord of 1985. Since then, the daily turnover in foreign exchange markets has soared close to $8 trillion, which makes coordinated intervention impractical today.
This leaves changes in monetary policies as the most effective way to impact the dollar. However, if the Fed were to ease monetary policy prematurely it could backfire and cause investors to sell dollar-denominated bonds, which would boost yields on them.
As Obstfeld observes, the principal reason inflation has receded from its highs is the Federal Reserve raised interest rates aggressively and has kept them at elevated levels.
He concludes: “These positive developments would have been impossible in a world where monetary policy was politicized, under presidential control and focused on the dollar’s external value than its far more crucial internal value.”
The clearest example of White House interference in monetary policy occurred ahead of the 1972 election when President Nixon pressured Fed Chair Arthur Burns to keep interest rates low as money supply growth and the economy accelerated. When wage and price controls were eliminated in 1973, inflation spiked to nearly 10 percent. It contributed to the breakdown of the Bretton Woods system of fixed exchange rates and was followed by a decade of financial market turbulence.
Weighing these considerations, investors should assess how committed Donald Trump would be to rein in inflation if he is elected president. While Trump was the beneficiary of a benign inflation environment globally during his presidency, there is little to indicate his policies contributed to low U.S. inflation: Witness the $8.4 trillion increase in federal debt that occurred, his jawboning of the Federal Reserve to lower interest rates and the increase in tariffs that raised import prices.
Looking ahead, the key risks are that the Fed could face political pressure to lower interest rates and global investors could lose confidence in the dollar if the proposals of Trump’s advisors are implemented.
Nicholas Sargen, Ph.D. is an economic consultant and is affiliated with the University of Virginia’s Darden School of Business. He has written three books including “Investing in the Trump Era: How Economic Policies Impact Financial Markets.”