How Tariffs Could Push the Fed to Cut Rates
Heads exploded across the establishment financial press on Wednesday when President Donald Trump proclaimed that tariffs and lower rates go hand in hand. Writing on Truth Social, Trump declared:
“Interest Rates should be lowered, something which would go hand in hand with upcoming Tariffs!!! Lets Rock and Roll, America!!!”
Predictably, the usual chorus of economists and media pundits rushed to dismiss Trump’s claim, arguing that tariffs lead to inflation and should push interest rates higher, not lower. But Trump’s instinct is correct: tariffs function as a form of monetary tightening by strengthening the dollar, making rate cuts a logical response.
Why Tariffs Strengthen the Dollar and Tighten Financial Conditions
Tariffs reduce the volume of imports, meaning fewer dollars flow overseas to purchase foreign goods. This decrease in the global supply of dollars strengthens the greenback, making U.S. exports more expensive while reducing the cost of non-tariffed imports. A stronger dollar exerts a disinflationary effect, offsetting the price pressures tariffs create on targeted goods.
The common refrain from establishment economists is that tariffs are purely inflationary and typically paid for by consumers. But Federal Reserve Chair Jerome Powell shot down this idea in his testimony to a Senate panel on Tuesday.
“Just generally, someone has to pay the tariff. It can be the exporter. It can be the importer. It could be a middleman,” Powell said. “And in some cases it does not reach the consumer and in other cases it does. It depends on the facts that we have not seen yet.”
This statement undercuts the claim that tariffs always lead to higher consumer prices. In reality, tariffs often get absorbed by foreign producers, wholesalers, or middlemen rather than being passed on to American consumers.
Trump’s Policy Prescription: a Coherent Vision
Trump’s economic instincts are sound. We can break down exactly how tariffs tighten monetary conditions—and therefore support Fed cuts—with a few bullet points:
- Reduced Demand for Foreign Currencies – Tariffs can make some imported goods more expensive, reducing U.S. demand for foreign goods. Since fewer dollars are exchanged for foreign currencies to pay for imports, demand for those currencies falls, supporting a stronger dollar.
- Trade Deficit Reduction – If tariffs successfully lower the U.S. trade deficit (by reducing imports more than exports decline), the net effect is fewer dollars flowing abroad, leading to dollar appreciation.
- Increased Foreign Demand for U.S. Assets – Tariffs can create uncertainty and risk for emerging markets and export-driven economies, prompting capital flight into U.S. assets, especially Treasury bonds. This increases demand for dollars, strengthening the currency.
- Tighter Financial Conditions – A stronger dollar makes U.S. exports more expensive and imports cheaper, which can dampen demand for U.S. goods and services. This acts as a drag on economic growth, much like an interest rate hike.
- Disinflationary Pressure – Because this dollar appreciation reduces the cost of imported goods and reduces foreign demand for U.S. produced goods, it can lower inflation.
- Higher Borrowing Costs for Emerging Markets – Many global businesses and governments borrow in dollars. A stronger dollar increases their debt burden in local currency terms, effectively tightening global liquidity.
What Trump understands is that the relationship between tariffs and interest rates is dynamic. If tariffs function as monetary tightening, then the Fed should logically offset them with rate cuts.
In reality, the Fed’s failure to cut rates in response to tariffs could create unnecessarily restrictive financial conditions, potentially slowing the economy more than needed. If Trump raises tariffs, the Fed should be prepared to cut rates accordingly.
The Washington-Wall Street consensus that tariffs and rate cuts are incompatible is wrong. Tariffs create conditions that strengthen the dollar and tighten financial conditions, necessitating rate cuts to maintain economic balance. Trump’s critics in the financial media are so blinded by their hatred of tariffs that they ignore basic economic reality. If tariffs act as monetary tightening, then rate cuts are the appropriate response.
Trump understands this. Treasury Secretary Scott Bessent understands this. At some point, economists and the financial press will likely—albeit reluctantly—come to grips with this reality.