I feel better about some of my past economic calls that haven’t panned out. Theodore Roosevelt’s quote—“The only man who never makes a mistake is the man who never does anything”—gives me some degree of solace. My mistakes show that I am at least willing to make a call.
My regular readers may remember that the “Three Yards and a Cloud of Dust” economic theme this year calls for a reduction in the growth rate of both economic activity and inflation pressure. Since then, events have occurred that are driving me to reconsider my call on inflation reduction.
Three Yards and a Cloud of Dust
My core economic outlook for 2025 was first published in November 2024, before the results of the national election. I have produced work showing that my core outlook carries only a 60% probability of working out. We live in a time of high speculation and uncertainty. My core outlook suggests we should have gross domestic product (GDP) growth at a lower growth level in 2025 than in 2024 and a slightly lower inflationary profile. What are other probable outcomes? What may be drivers that throw the core outlook into a hat?
The flies in the core ointment aren’t centered in consumer sentiment, spending or other raw demand issues. The variables driving changes on macro-outcomes may be the magnitude and timing of what I have since called President Donald Trump’s Four Buckets on economic fundamentals:
- Tax law changes (lowering taxes).
- Tariff changes (raising tariffs on China imports by 10% and all others under consideration).
- Deportation of illegal immigrants.
- DOGE efforts to rationalize and shrink the size and amount of government spending.
We need to remember that Trump has inherited a reasonably strong economic picture: 4.1% unemployment1, 2.5% GDP growth2 and inflation at 2.9%3 are all baseline fundamentals showing a strong economic backdrop. That said, the real problem Trump inherits from the Biden administration is two-fold. Record deficits and the potential of rising inflation pressures may weigh heavily on the economy going forward. But, for the purpose of this commentary, we put those risks aside for the moment.
In the work from late last month, I outlined the raw, probable impact on inflation and GDP growth rates as follows:
Net Effects on Growth and Inflation – Still Guesswork
| Real GDP Growth | Projected Inflation | |
|---|---|---|
| Base Case | 1.5% – 2.5% | 2.6% |
| Tax Law Changes | + | – |
| Tariff Changes | – | + |
| Deportation of Illegal Immigrants | – | + |
| DOGE Efforts | + | – |
The two highlighted efforts may have a greater impact on 2025 economic activity than the two other issues, as the timing of tariff changes and deportation of illegal immigrants doesn’t rely on congressional approval. On balance, our view (depending on details and timing of implementation of those details) suggests downside pressure in GDP growth and upside pressure on inflation may be the net result during 2025. It needs to be highlighted that the major impact of these changes probably won’t be felt until 2026.
First Actions Expected – Congressional Approval Not Needed
As noted above, I suspect we will see rather quick action from the Trump administration to take place in the de-immigration and the tariff arenas. Note my view that on balance, these two buckets may contain provisions that increase inflation pressures and reduce overall macro-growth influences.
The latest poll of 70+ economists now expects inflation to be 0.4% higher this year than their earlier estimates from the poll taken in October 2024.4 The economists were calling for 2.3% inflation during 2025 and raised their view to an expected 2.7% inflation this year. 4 That said, the Consumer Price Index was +2.9% in the latest reading, so most economists are still looking for a modest reduction in price pressure this year. 3
As noted above, my outlook in the core case was calling for inflation of 2.6% (Personal Consumption Expenditures), which was at 2.8% at the most current read. 2 I was looking for a slight reduction in inflation pressure in 2025.
Why are most economists suggesting that inflation won’t recede as much as they believed prior to the national election? First, most inflation indicators (year-over-year) bottomed out last summer and have been slowly drifting upwards since. Additionally, I also believe the upward revisions have to do with the probable timing of the release of the four buckets in Trump’s agenda as noted above.
I suspect we will start to see the impact of two of the buckets quickly—certainly by the end of this year. Those two buckets, which don’t need strict congressional approval prior to launch, are de-immigration actions and certain tariff actions. As noted above, both proposed actions contain the potential of lowering economic growth and raising inflationary pressures.
Countering these two buckets’ potential negative macro effects are probable positive economic actions of lowering tax rates and the hopeful efficiency-induction and waste reduction actions of the DOGE efforts, both of which may require congressional approval. As such, these more positive actions may not come into effect until 2026.
Let’s look at some data that supports the less-than-positive economic reaction of increased actions of de-immigration and higher tariff rates.
De-Immigration
The folks at the Brookings Institute and the Tax Foundation have completed some serious work on the potential impact three of Trump’s economic buckets—tax reductions, immigration and tariffs—may impact on the economy. Consider the following points:
- How many non-documented immigrants are now in the U.S.? Nobody really knows. I’ve seen estimates as high as 11 million.
- Some knowledgeable believe that roughly 70% of non-documented immigrants have jobs. 5 If so, that means about 3% of the workforce is comprised by non-documented immigrants.
- 17% of farm production workers are non-documented immigrants. 6
- 13% of construction workers (both housing and commercial) are illegal immigrants.6
- 9% of workers in the hospitality industry are illegal immigrants. 6
A question to ask: Are non-documented immigrants paid less than others? I don’t know. But if yes, as workers are uprooted from their current jobs and replaced with other workers, higher wage costs may be in store, particularly in industries where currently non-documented immigrants comprise a significant portion of the industry workforce. The net effect may be to increase cost/push inflationary pressures within those industries.
Tariff Increase
Most economists (including this one) view tariffs as basically a consumption tax, a tax which can lower overall final demand and/or increase inflationary pressures. Now, some tariffs are appropriate from a national security standpoint, and as such carry real importance beyond raising money for government use. Tariffs on imports from China can, and in many cases probably should, be viewed in the national security lens. These types of tariffs don’t require congressional approval prior to launch or increase.
In addition to an increase in tariff rates placed on imports from China, Trump is calling for a universal 20% tariff rate on all imports from all countries outside of North America. He is now considering imposing a 25% tariff on imports from both Mexico and Canada.
Why should we view tariffs as a consumption tax? There are three responses producers and consumers can take on imported goods which carry a tariff:
- The importer can “swallow” the tariff cost. In this case, the importer’s profit margin shrinks.
- The importer can stop importing the good to the U.S.
- The importer can raise the goods’ price. In which case, consumers have one of three options:
- Pay the higher price, which is inflationary in nature.
- Look for an alternative good to replace the good whose price has risen due to the tariff application.
- Not buy the good at all.
The replacement option may be moot, unless the purchaser finds a domestically-manufactured option, as all imported versions of the product will have to pay a tariff. If the purchaser pays the increased cost, some degree of upward pressure on inflation rates will occur. I’m of the opinion that tariffs will be increased to partially pay for the desired tax reductions which Trump has outlined in his campaign. Goodness knows, the nation can’t afford a new, large addition to the deficit.
Final Word
I believe it is still early to make the call for higher-than-expected inflation pressure to build this year due to political decisions, but the possibility of such an outcome is present. If inflation pressure does build this year, my view that the Federal Reserve will reduce Fed Funds by one to two more steps in 2025 may indeed not occur.
All that said, we are in a time when speculation is high, and certainty is low. That is why I’ve placed a low 60% probability on my core economic outcome for 2025. We have a new president who has desires, each of which will have the capacity of altering economic outcome in a meaningful way.
Hold on to your hat. We will see how the winds blow this year.
Sources:
1 Bloomberg
2 Bureau of Economic Analysis
3 U.S. Bureau of Labor Statistics
4 Wall Street Journal
5 Trend Macro
6 NewAmericanEconomy.org
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