In the latest edition of the Economic Compass, Diane Swonk, chief economist and managing director of KPMG Economics, writes that “The shock of the new tariffs roiled financial markets around the world. The risk of a recession went from a remote possibility to probable in a matter of months. The betting markets had the odds at close to 60% as of April 7.”

She goes on to write: 

This edition of Economic Compass takes a closer look at the fallout from the most recent round of tariffs. Special attention will be placed on why economists dislike tariffs. Historically, tariffs have done more damage than good and triggered a host of unintended consequences.

If the new tariffs hold, the economy could slip into a recession with a bout of stagflation within months. Stagflation is uncommon and occurs when growth slows and both inflation and unemployment rise.

The Federal Reserve will likely cut short-term interest rates, but not until it is sure that the tariff-induced inflation will abate. Our baseline forecast has the first rate cut occurring in the fourth quarter, but a deeper recession could move that timeline forward.

She also provides the following top 10 list of why economists dislike tariffs. 

1) Regressive. The tariffs announced on April 2 amount to a $750 billion tax increase, the largest in modern history. That is the equivalent of a major sales tax, the most regressive form of tax.

Low-and middle-income households are hit harder than high-income households due to their reliance on goods purchases. Small businesses suffer more than large companies due to narrower profit margins.

2) Stoke uncertainty. Tariffs trigger retaliation, which can rapidly escalate. That spurs uncertainty, measures of which have already eclipsed the pandemic globally. Domestic measures of uncertainty are close to all-time highs and likely did the same, given financial market volatility over the last week.

The fact that the tariffs are issued via executive orders further muddies the water. Tariffs raised with the stroke of a pen can be reversed almost as fast, which adds to our collective paralysis.

3) Boost inflation. The April 2 tariffs are significantly larger than anything the president levied during his first term. They will cascade through supply chains and raise costs, much of which will be passed along to consumers.

Weaker demand and falling commodity prices will blunt the boost to inflation due to tariffs. Another mitigating factor could be a strong dollar. Tariffs typically trigger an appreciation in the value of the dollar.

Thus far, that has not occurred. Fears of recession are forcing the dollar lower against the currencies of our trading partners. That makes imports more expensive and compounds the effects of tariffs on costs.

4) Spark financial market volatility. Financial markets have been late to acknowledge the fact that tariffs are as much a threat as a reality. That shifted on April 2. High tariffs turned into an undeniable fact.

The Volatility Index (VIX) for the S&P 500 stock index jumped to its highest levels since the pandemic in recent days; it is well above the highs of the 2018-19 trade war.

Financial markets are pricing in the risk of recession and assessing the exposure U.S. firms have to economies abroad. About 40% of profits of the stocks listed in the S&P 500 come from outside the U.S. That makes them vulnerable to how the global economy weathers the tariff storm and prime targets for retaliation.

Markets are hoping the Fed can cut rates aggressively. Fed Chairman Jay Powell has pushed back on that notion, saying after a speech on April 4 “We are in no hurry” to cut rates.

The challenge for the Fed is the one-two punch of inflation and weaker growth, or the stagflation that tariffs could trigger. The Fed has internalized the lessons of the pandemic and those of the 1970s. That means it needs to hold the line on rates until it is sure that inflation will recede.

5) Job losses outweigh job gains. Tariffs reduce competition, with the most protected industries not hiring enough to offset the blow to the hardest hit industries. This is especially true when there are so few domestic substitutes.

Few goods are 100% American made. That limits the industries that benefit from the protection of tariffs, while increasing those exposed to the downside.

6) Undermine productivity. Tariffs reduce competition, divert investment to less productive, protected industries and stifle large infrastructure investments. That undermines overall investment in and adoption of new technologies.

A recent study on the Gilded Age, when tariffs dominated our federal revenues, is particularly chilling. Some of the most “protected” firms exhibited a setback in productivity growth. Firms diverted funds to curry favor with politicians and lobby for their own interests.

Banks tighten their credit standards during periods of high uncertainty, especially for firms that may be exposed to tariffs. A widening of spreads between investment grade and junk bonds makes it harder for firms that need credit most.

7) Poor revenue generators. Tariffs have a more direct effect on demand than other taxes. They often fall short of estimates of what they can generate in terms of revenues.

The leverage of executive orders to implement tariffs further undermines their revenue-generating power, as they could be revoked at any point. That is why the nonpartisan Congressional Budget Office does not include tariffs issued via executive order in its scoring of the federal budget.

8) Erode export competitiveness. The blow to productivity, tighter credit standards and diversion of resources to protected sectors diminish our ability to export. Retaliatory tariffs, boycotts of US goods, curbs on foreign investment and travel to the U.S. will further undermine exports.

9) Fail to level the playing field. Tariffs act as a stick instead of a carrot when lowering trade barriers. They often backfire as trade tensions escalate, which hurts our competitiveness at home and abroad.

Multilateral trade agreements work better at reducing hurdles to trade but require countries to adhere to rules and global enforcement mechanisms. The trust in global arbiters of trade conflicts eroded with China’s ascent to the global stage.

This year, the administration further weakened funding for rule-setting organizations and overrode the USMCA to penalize Mexico and Canada. That could have a lingering effect on our ability to negotiate trade pacts.

10) Stokes nationalism. Last, but by no means least, tariffs tend to stoke nationalism. The Smoot-Hawley Tariff Act of 1930 triggered a trade war between the US and 10 of the 25 countries affected by the tariffs. The tariffs covered more than 20,000 goods.

In response, global trade plunged 67%, which threw the global economy deeper into the depths of the Great Depression. Those losses helped sow the seeds of World War II.

The Marshall Plan and efforts to rebuild after that war were seen as key ingredients to a more lasting peace. The postwar dismantling of trade barriers was another component. The hope was that economic integration would diminish the incentives to go to war.

In more recent decades, that view shifted. There was a hope that countries that embraced trade would be more open to the tenets of democracy. That did not prove to be the case. China and Russia are two key examples.

The full report can be found here. 

Related Content: ONGOING COVERAGE: Tariffs — Latest Updates & Market Impact