Tariffs Call for Cuts. The Fed Is Finally Coming Around.

(Illustration by Jason Allen Lee)

About the author: Mark Penn is chairman and CEO of Stagwell, a technology-based marketing services firm.

The Federal Reserve seems to have finally come to its senses. The U.S. central bank has signaled it will cut rates at next week’s Fed meeting—an important step forward for the economy.

Yet naysayers and fearmongers continue to ring alarm bells, arguing that rate cuts in a still uncertain tariff environment risk harming the economy. Their mistake confuses tariffs—a form of taxation—with inflation induced by excess demand.

Rate cuts make sense. Keeping interest rates steady now over this fundamental misconception would be a repeat of the catastrophic decision-making in the 1930s that contributed to the Great Depression.

Not all things that look and act like a duck are in fact ducks. Nominally, tariffs do increase prices, much in the same way that New York adding to its sales tax would increase prices in New York. But the Fed wasn’t established to fight tax increases—its mandate is to build employment and moderate the kind of inflation that occurs when there is too much money in the money supply. Tariffs don’t continuously push prices up in the same way that conventional inflation does.

According to basic economics, taxes aren’t inflationary because they contract the economy by taking money out of the private sector and putting it into the Treasury. As President Donald Trump likes to boast, tariffs have already brought in $150 billion in revenue.

Tariffs may raise prices once, yes. But they push up prices because supply is more expensive, not because there is excess demand. The supply curve moves up, raising equilibrium prices and lowering demand. Consumers now have less disposable income, and businesses have higher input costs. That isn’t a signal of overheating that the Fed must tamp down. It is a contraction of the economy the Fed should move to counteract.

Even liberal economist Paul Krugman calls tariffs a tax. If Congress bumped up the income tax by 5% today, nobody would fear inflation. The Fed would be more inclined to cut rates than raise them in that case, recognizing that higher taxes reduce demand.

A rate cut would also provide the labor market the support it needs right now. Tariffs squeeze the labor market in the short term: As companies face higher input costs, they invest less, pull back on hiring, and freeze wages. And if foreign countries retaliate, as they often do, exporters sell less abroad, decreasing the number of jobs.

The labor market is already weakening. Unemployment is at 4.3%, the highest it has been since 2021. Nonfarm payroll growth has slowed to unprecedented lows, with job growth totaling 22,000 jobs in August—more than 50,000 fewer jobs than economists predicted. Job losses totaled 13,000 in June. These are the lowest job growth numbers since the peak of the Covid-19 pandemic, and the first time the U.S. has posted negative job growth in nearly four years. The Fed should be countering this contraction by cutting interest rates next week by 50 basis points, or half a percentage point, instead of worrying itself with fears of tariff-induced inflation.

The Fed has gotten this wrong before.

A long time ago, in my Harvard thesis, I studied the 1930 Smoot-Hawley Act tariffs. The act raised average taxes on dutiable imports to 52.8%. Within two years, imports and exports collapsed to about 30% of 1929 levels. Farm incomes dropped nearly 20% below pre–World War I benchmarks. Unemployment soared, particularly in manufacturing and agriculture.

The Federal Reserve failed to react. Fearing a run on gold and an increase in inflation, it refused to ease monetary policy. In fact, it actually raised rates. That mistake ultimately contributed to the severity of the Great Depression.

Lowering rates today would prevent such a mistake from occurring once more. Trump understands that.

He is undertaking a bold economic move to rebalance the domestic economy and encourage domestic production by making it more expensive to import. He is also using tariffs to wring trade concessions from countries that were keeping U.S. goods and investment out of their markets. Whether the Fed’s governors like this shift in trade policy or not, they should support the economy through it—not act out of political motive or flawed economic principles.

Trump has been urging the Fed to cut rates for months because he knows it is the right response to the combination of tariffs and reduced government spending. He is counting on the Fed to understand the transitional impacts of his economic plan and move to expand growth in the private sector.

It took a while for the Fed to let go of the flawed logic that insists on holding rates up in the name of tariff-induced inflation, but Powell looks to have finally come around. He should come through with a rate cut before it is too late.

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