Commentary
Federal Reserve Chairman Jerome Powell stated on April 16 that President Donald Trump’s tariffs would likely lead to higher rates of inflation. He made this claim before an audience at the
Economic Club of Chicago. This somewhat gratuitous statement must be examined in light of sound economic theory:
Do tariffs actually cause inflation?Basic Economics
Classic economics defines three primary sources of government funding: taxation, debt, and inflation. To tax is to levy fees on income, sales, property, and other activities to raise revenue for expenditures. Second, borrowing enables governments to finance operations through future tax revenues. Lastly, expansionary monetary policy may increase the money supply relative to the output of goods and services, raising prices and reducing the currency’s value. As Milton Friedman famously argued,
this phenomenon is known as inflation.
Powell, It’s the Balance Sheet
The Fed has three means of fulfilling its dual mandate:
- Changing the target short-term overnight rate
- Setting reserve requirements
- Open market operations
While changes to interest rates and reserve requirements influence borrowing and liquidity, the most potent tool recently has been the Fed’s
large-scale asset purchases in the open market. These purchases are financed with previously nonexistent money, described in Latin as
ex nihilo, or “out of nothing.” When the Fed expands its balance sheet in this way without a corresponding increase in the production of goods and services, the result is inflation.
The Expanding Money Supply
In February 2020, the U.S. money supply stood at $4.1 trillion. By March, the COVID-19 pandemic had spread rapidly across the world. In a whirlwind of uncertainty, many businesses shut their doors, millions were laid off, and the U.S. economy fell into recession. As a counter-cyclical measure, the Federal Reserve expanded the money supply from $4.1 trillion to $8.97 trillion in about two years. Consequently, U.S. inflation, as measured by the Consumer Price Index (CPI), surged from 1.4 percent in January 2021 to 9.1 percent by June 2022, on an annualized basis. After several months of elevated inflation, the CPI began to decline as the Federal Reserve reduced its balance sheet by $2.24 trillion,
bringing it down to $6.73 trillion as of mid-April 2025. The United States has a monetary problem.
Ballooning National Debt
From a fiscal perspective, the U.S. national debt surpassed $1 trillion for the first time in its then-205-year history at the end of President Ronald Reagan’s first year in office in 1981. The deficit expanded significantly during the Reagan years as the administration pursued tax cuts, strengthened Cold War defense spending, and battled inflation. By the close of the Clinton administration, the national debt had grown to $5.68 trillion. President Bill Clinton achieved a budget surplus in his final year, driven largely by spending reforms and the post-Cold War reduction in defense outlays.
