ERIC WINOGRAD
Tariffs are a tax, and they’re a tax paid by the domestic entity that imports goods from overseas. And like any tax, they have economic impacts. Tariffs push prices up, and they push growth down.
Because it’s the United States that’s imposing most of the tariffs at this stage, we think the implications for the United States are going to be the most significant, certainly in the form of increased prices. Because it is domestic actors who pay this tariff at the border, it’s very likely that they will be passing some of that on to consumers. What we’re talking about is a scenario in which prices go up, and households thus have less money to spend, and so growth goes down..
But that isn’t uniform. And in Europe, for example, it [00:05:00] isn’t clear that you’re going to get both higher prices and lower growth.
SANDRA RHOUMA
Exactly. In Europe, the impact is quite different from the US in that it’s not necessarily inflationary. Actually, it could be the opposite. It adds an additional disinflationary driver in a region where disinflation was already well underway. And the disinflationary driver comes not so much from the direct impact of tariffs from the US on Europe, but from the indirect impact of tariffs imposed from the US to China.
You can think about, you know, Chinese exports to the US now essentially reduced to zero. And China will need to find other markets to export [to]. And it’s naturally going to export more to Europe, given the size of the market, right? To do that, they might decrease the price of [the] goods they’re going to sell to European markets and therefore export disinflation to Europe. While for growth, it’s clearly negative.
ERIC WINOGRAD
It’s negative in Europe from a growth perspective because Europe does export a lot to the United States, right?
SANDRA RHOUMA
Exactly. So again, you think of a country like Germany: it exports close to 4% of its GDP to the US. You have other countries that are more insulated, but overall for the region, the impact is clearly negative, and it’s recessionary for some countries.
ERIC WINOGRAD
Yeah. And it just points out that this is a more complicated issue than simply the US imposing tariffs on imported goods. It has global impacts, and it has indirect impacts too.
But when we bring that back to the economy, the fact that we don’t know is itself a problem, right?
SANDRA RHOUMA
Exactly. The uncertainty is a hit to growth already.
ERIC WINOGRAD
I want to focus a little bit on that word “uncertainty,” because that really is, I think, the dominant paradigm, not just in financial markets but for central banks at this point as well. The ECB has already cut rates significantly this year; the Fed hasn’t. So for the Fed, it’s a matter of restarting something. For the ECB, it’s merely a matter of continuation.
SANDRA RHOUMA
Exactly. The ECB is much more focused on inflation than on growth. And if services inflation continues to ease, and eases faster than expected, then, you know, it’s a green light for them to continue.
ERIC WINOGRAD
We’re more confident that the ECB will cut, and cut aggressively, than we are that the Fed will. And so most of the time, we would say, “Okay, that’s a good reason to be long in the US dollar.” And yet the dollar has weakened over the course of the last couple of months. What does that mean for the euro area? What does it mean to have a stronger euro?
SANDRA RHOUMA
I think there is a willingness from policymakers at the ECB to strengthen the role of the euro, not necessarily the euro itself. And if the strong euro is now a structural [phenomenon], they will have to find kind of the sweet spot where the euro is more important in international transactions, without necessarily, you know, being a threat to their inflation target.
ERIC WINOGRAD
It’s a tough balance, right? Because the US also, you know, the US officially has a strong dollar policy. What we mean by the strong dollar policy is the idea that the US does play a predominant role in global trade and in settling global transactions. It isn’t meant as a specific reference to the exchange rate of the currency at this point, but it does have an implication for the exchange rate, which is that there’s always sort of this excess demand for dollars because of the role it plays in the global financial system.
And that’s one of the things that the current administration seems to want to push back against. It would like to have a weaker dollar because that would further its goals of reducing the trade deficit. But how you hit, and I really like the way you said that, how you hit the sweet spot…
SANDRA RHOUMA
Yeah.
ERIC WINOGRAD
... of being an important currency but one whose exchange rate still allows you to hit your economic goals, well, that’s a tough trick to pull, especially in what is the world’s largest market, and one that really is resistant to policymakers controlling exchange rates.