Why This Former Central Banker Sees U.S. Economy in a ‘Wile E. Coyote’ Moment

Raghuram Rajan, during meetings of the International Monetary Fund and World Bank in Washington, D.C., in April 25. (Tierney L. Cross/Bloomberg)

The U.S. stock market and economy’s resilience over the past six months has left it in a position like the Road Runner cartoon Wile. E. Coyote—suspended in midair, waiting for reality to kick in, after running off the edge of a cliff, economist Raghuram Rajan says.

“They have taken a very strong economy and subjected it to a lot of shocks—some of which people anticipated and moved ahead of. It will take time to show up,” says Rajan, who came into the spotlight before the 2008-2009 financial crisis, warning that people were underestimating the amount of risk and leverage building up. “You have to look closely at the tea leaves to see the impact coming.”

The former chief economist for the International Monetary Fund and head of the Reserve Bank of India now teaches finance at the University of Chicago Booth School of Business.

The typical gauges offer a much more reassuring view of where things stand than many economists are offering. The S&P 500 closed at a record high on Thursday and the economy is still growing, without signs of a significant increase in inflation. That has given the Trump administration leeway to push further in a range of areas, such as tariffs, his deficit-expanding tax-and-spending legislation, pressure on the Federal Reserve to cut interest rates, and mass deportations.

All that has economists such as Rajan worried about what is ahead. Take tariffs. Several major trading partners, including the European Union, South Korea, and India, are in the midst o f negotiations to strike even cursory agreements to keep higher tariffs from snapping into place on Aug. 1. Even if that doesn’t happen, the average effective tariff sits at above 20%, 10 times where it was at the start of the year, the Yale Budget Lab estimates.

Among the reasons tariffs haven’t significantly affected the economic data is that the administration has extended deadlines for negotiations, delaying their effects, in some instances. Companies have also tried to get ahead of higher tariffs by building up inventories, rerouting trade, or, in some cases, eating the extra costs until they get a better sense of where trade policy settles, Rajan tells Barron’s.

It isn’t just trade. Rajan sees a delayed impact on the economy from much of what the Trump administration is doing, including pressing Fed Chair Jerome Powell to cut rates.

Trump recently showed lawmakers a letter he said would fire Powell but has since said he wasn’t planning to do so. The pressure has continued nonetheless, including with Thursday’s tour of the Federal Reserve’s headquarters in Washington, D.C. and criticism of the bank’s $2.5 billion renovation of the building. Trump, who became only the fourth sitting president to visit Fed headquarters, has suggested he could dismiss Powell if there was any fraud related to the renovation.

“The Fed isn’t in a position to have a good political argument: It’s a bunch of technocrats who can’t say what they want,” Rajan says. “In the court of public opinion people start asking: ‘What is this $2.6B renovation? Is this the Taj Mahal on the Potomac?’ If you parse the details, it’s a lot more understandable. But who has time to do that and the Fed gets put in the corner.”

Rajan, who also endured political pressure when he headed India’s central bank, doesn’t think Trump will ultimately push Powell out. For one, he said, the Fed chief could be a useful scapegoat if the economy begins to struggle.

The economist also doesn’t think Powell should resign before his term is over. “It would weaken the institution because it would say: ‘Fire away at the Fed and you’ll get a resignation. In the interest of the country, he should fulfill his term.’”

Even with a “Poodle Fed” led by a less independent leader, Rajan says, regional Fed governors and the Fed’s board would make it difficult for the central bank to rapidly change course.

“The Fed is a red herring. It is just is a reflection of the [administration’s] broader view that the old economics—central bank independence, low tariffs, open barriers and reasonable immigration—don’t make sense.”

His concern is that the U.S. economy is headed for a Wile E. Coyote moment, running fast over the cliff, but with gravity suspended, for now. “They aren’t paying enough attention to the downsides of the immigration crackdown on growth; they aren’t seeing the inflationary or growth effects of tariffs so they are pursuing bolder policy,” Rajan says. “It could show up at the same time and be a shock to the economy.”

Rajan sees parallels to Brexit, the U.K.’s 2016 decision to leave the European Union. “Early on, the allegations were that economists who were warning it was a terrible idea to cut off your biggest market were being Chicken Little and nothing bad was going to happen,” Rajan says. “It took a number of years to see it was a terrible shock to the U.K. economy. Now, if you ask the British, most will say they wish they could reverse it.”

Write to Reshma Kapadia at reshma.kapadia@barrons.com