How will Trumponomics work out?

At this writing, a week after the US national elections, it appears that President-elect Donald Trump’s Republican party will gain control of both chambers of Congress, enabling him to enact his economic agenda. He has been clear about his intentions: tariffs to protect the United States, tax cuts to help business, and the expulsion of unauthorized immigrants.

Equipped with textbook macroeconomic principles, but also the humility appropriate for any forecast, I predict that he will be disappointed by the results. I also predict, however, that the outcome will not be the economic catastrophe that his critics warn of—unless he forces the US Federal Reserve to do his bidding, in which case all bets are off.

Take tariffs. Trump has promised to impose a 10 percent tariff on all imports and a 60 percent tariff on those from China. (Some argue that he may use this as an opening gambit in a negotiation and back down if he gets what he wants. I am skeptical, if only because of his apparent love for tariff revenues.)

The initial effects may work largely as he hopes. US imports will drop, tariff revenues will increase (although not by as much as he predicts, precisely because the tax base, namely imports, will decrease), and the country’s trade deficit will decrease.

But this will be just the beginning of the story.

Assume first that there is no tit-for-tat tariff retaliation by China or Europe. As US demand shifts from foreign to domestic goods, higher demand for domestic goods in an economy that is already at full employment will put upward pressure on prices. That pressure will force the Fed to increase interest rates to keep inflation under control. Because of both higher rates and an improved trade balance, the dollar will strengthen, just the opposite of what Trump wants. US exports will suffer, and the trade deficit will not improve much, if at all.

Chinese and European retaliation, both likely, modify the story, but not for the better. US exporters will suffer more. The trade balance may not improve at all. On net, lower imports and exports may lead to less rather than more economic activity. Even then, tariffs will still lead to higher inflation and higher interest rates, leaving the Trump administration with little to show for the tariff increase.

Unhappy exporters, little improvement—if any—of the trade deficit, likely higher inflation, and a stronger dollar, will not make Trump happy. What will he do?

Doubling down would be in character. But exporters’ opposition and the inflation effects of further tariffs are likely to deter him from taking that path. Backing down and reducing tariffs is equally unlikely. Thus, the most likely scenario is that tariffs will stay. If so, the initial good news on the trade and output fronts, maybe lasting up to the 2026 midterm elections, will fade away, leaving the usual adverse effects of less trade, i.e. less use of comparative advantage.

Turn to immigration: Trump has promised to deport unauthorized immigrants. They are estimated to number around 11 million, and the talk is of deporting about 1 million a year.

Total US employment is about 160 million people. So, if he deported 1 million immigrants a year, he would decrease employment by 0.5 percent a year, with a final total decrease of 5 percent. Job vacancies would jump and remain high, as would the ratio of vacancies to unemployed workers, leading to sustained inflationary pressures. The Fed would respond by raising interest rates, causing exchange rate appreciation—again, not what Trump is hoping for.

This will not happen, given the magnitude of the numbers in this scenario. Unhappy employers, especially in agriculture, construction, and restaurants, would quickly grow vocal enough to slow the pace of deportation. Inflation, which has also proven to be extremely costly politically, would likely make Trump think twice. Thus, one must assume that deportations, while they will occur, will be largely symbolic, involving tens or hundreds of thousands rather than millions of people. To the extent deportation happens, it will lead to inflation and higher interest rates, and a potential conflict with the Fed. More on this below.

Turning to taxation: Trump has promised to extend the tax cuts enacted in 2017. This is very likely to happen. In addition, he has, at different times, suggested that Social Security benefits and tips become fully nontaxable, that the state and local tax deductions be increased, and that the corporate tax rate, which was reduced from 35 to 21 percent in 2017, be further decreased to 15 percent for manufacturing firms. These additional measures may, however, be opposed by a number of conservative House Republicans, leading to a smaller but still substantial fiscal package.

Any discussion of fiscal plans must start from the fact that the federal budget deficit is already extremely large. The ratio of federal debt to GDP is 100 percent. The deficit is around 6.5 percent of GDP, and the primary deficit is around 3.5 percent. If the 2017 tax cuts were left to expire, that would shrink the deficit by roughly 1 percent of GDP in 2025. But even under this assumption, the Congressional Budget Office forecasts were for primary deficits of about 3 percent as far as the eye could see. The measures that Trump is considering would increase that number by roughly 1 to 2 percent, leading to a 4 to 5 percent sustained primary deficit and a rapid increase in the debt ratio. Were the interest rate and the growth rate to be roughly equal, which looks like a reasonable hypothesis, this would imply an adjustment of the primary deficit of 4 to 5 percent of GDP, or equivalently, 16 to 20 percent of the federal budget, to stabilize the debt ratio. This is an extremely large number, and there is no reason to think that corporate tax rate cuts, even if they boosted investment and potential growth, will substantially reduce the deficit over the next few years.

If Trump enacted all the measures he has suggested, a question would be how many years it will take for investors to question the risk-free status of US Treasuries. Nobody knows for sure whether such questioning would start during his presidency or after. If it were to happen, and investors started pricing a risk premium, it would probably lead to a more responsible fiscal policy. Leaving aside this risk issue, what is likely, however, is that a further fiscal expansion, starting from an economy close to full employment, will lead to inflation and, by implication, higher Fed policy rates and a stronger dollar. Once again, this scenario will trigger a potential conflict with the Fed.

Thus, perhaps the most crucial issue is what the Fed will do. If it sticks to its mandate, it will stand in the way of some of Trump’s hopes from the use of tariffs, deportation, and tax cuts. It will have to limit economic overheating, increase rates, and cause the dollar to appreciate.

The big question is thus whether Trump can force the Fed to abandon its mandate and maintain low rates in the face of higher inflation. Fed Chair Jay Powell has made clear he remains committed to the mandate and to staying at the Fed as chair until his term as chair expires in May 2026 (his term as board member ends in 2028). Current Fed board members are unlikely to follow a different line. But one board position opens in January 2026, and Trump could seek to name a more docile board member to the seat. If this is the case, and the board goes along (which is unlikely), the result will be low rates, overheating, and higher inflation. Given the unpopularity of high inflation, not to mention the reaction of financial markets to the loss of Fed independence, this prospect may be enough to make Trump hesitate to pursue this option.

I have left out other possible economic outcomes that are macro-relevant, including deregulation (especially of the financial system), energy policy, giving free rein to the crypto industry, and the effects of higher economic uncertainty on investment and consumption. If I had to summarize my predictions: The Trump economy may look good for a while, with strong growth (the perceptions of voters in the last election notwithstanding, the Biden administration has left the Trump administration a strong US economy, a precious gift in this context). Predicting an immediate catastrophe or a stock market crash, as some did in 2016, is unwise. But the initial positive effects will likely fizzle and possibly reverse, perhaps before the end of Trump’s mandate.