US tariffs could cause stagflation, economist says

The Trump Administration’s imposition of tariffs on Mexico and Canada as well as the tariffs imposed on China risk causing stagflation in the US, a leading economist told the Bermuda Risk Summit, taking place in Bermuda this week.

Greg Daco (pictured), chief economist at EY-Parthenon, said the US economy had outperformed most other economies in 2024 but was showing signs of slowing down this year.

Daco said income growth was slowing down, while 50% of consumer spending – also slowing down – was driven by the top 10% of income earners.

The increased policy uncertainty – including President Donald Trump’s on again-off again tariffs on Mexico and Canada were causing businesses to take a wait and see approach and put off spending decisions.

Daco said uncertainty was 90% higher than it was in 2018 when tariffs were last imposed.

In the meantime, tariffs on steel and aluminium are likely to go into effect tomorrow which could drive up the cost of cars and home appliances, while inflation is likely to increase in the second half of the year as a result.

He said the Administration was focused on two results from tariffs. One was to bring manufacturing back onshore while the other was to collect revenues to pay for tax cuts.

Daco said the 25% tariff rates on steel and aluminium were the highest since the 1930s when protectionism and trade wars had extended the Great Depression.

He added that the uncertainty was also causing volatility in the financial markets where stocks had lost virtually all of their gains since the November election while Treasury bond yields had been erratic.

He said declines in the stock market most affected the wealthiest, who were the main drivers of consumer spending.

“We have all the ingredients for a sharper pullback if trade uncertainty continues,” he said.

He said the actual imposition of tariffs on Canada and Mexico would cut economic growth by 1.5% while driving up inflation by 1.7%. the effect on Canada and Mexico would be worse, he said. It would also slow growth in the Eurozone.

Daco said the prospect of stagflation – stagnant growth and high inflation – made it difficult for central banks to decide what to do about interest rates. If banks raised interest rates to get inflation under control, they could cause recession while cutting interest rates to encourage growth could lead to higher inflation.

In the meantime, uncertainty made it less likely that central banks would cut rates now while there was a 50% chance they could either cut rates or raise them in the medium term.

Further, the US government needed to get its fiscal deficit under control. Currently running at 6.5%, interest payments on the debt were the highest since the Second World as a percentage of gross domestic product.

He said the Department of Government Efficiency (DOGE) cuts being implemented in the US would make little difference to the overall deficit since two thirds of spending went on mandatory entitlements like Social Security and Medicare.

To offset the increases in spending. Daco said the government needed to raise taxes, but this would not happen. Instead plans to extend tax cuts passed in Trump’s first term would add to the deficit and national debt while doing little to stimulate the economy.

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