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How Trump can achieve sustained growth

Published: 23 Feb. 2025, 20:00

Michael R. Strain

The author is director of economic policy studies at the American Enterprise Institute.

As investors, business leaders and policymakers consider America’s economic outlook, two things should be front of mind. First, the U.S. economy is very strong. And, second, President Donald Trump’s populist policies pose one of the biggest risks to its continued growth.

In January, core consumer-price-index (CPI) inflation, excluding food and energy prices, rose by 0.4 percent month on month — more than economists had expected, and double December’s increase, pushing the year-on-year rate to 3.3 percent.

Financial markets took note. But it has been clear for months that the Federal Reserve is not succeeding in pushing inflation toward its 2 percent target. Underlying inflation has been stuck since the spring of 2024. Using the personal consumption expenditures price index ,excluding food and energy prices, year-on-year inflation was either 2.7 percent or 2.8 percent in seven of the last eight months. It was 2.6 percent in June. And 12-month core CPI inflation has been either 3.2 percent or 3.3 percent in each of the last eight months.

President Donald Trump arrives to speak at the Future Investment Initiative (FII) Institute summit in Miami Beach on Feb. 19. [AP/YONHAP]

Meanwhile, the labor market is holding steady. The headline monthly unemployment rate has remained between 4 percent and 4.2 percent since May, and has been falling for the past two months. In fact, the labor market may be tightening. A broader measure that accounts for involuntary part-time schedules and marginal labor-force attachment implies that slack in the labor market may have been falling since July.

An inflation rate stuck above the Fed’s target and a strong labor market reflect robust economic fundamentals. Monthly employment gains have been strong and layoffs remain low, supporting household incomes and the consumer spending that has fueled the economy’s expansion. Economic output grew above its underlying potential in the second half of 2024. At the time of writing, the Federal Reserve Bank of Atlanta estimates that the economy is on track to grow 2.3 percent in the current quarter, arguably above its sustainable rate.

The risk of inflation reaccelerating is greater than the risk of labor-market deterioration. As I write, market prices imply a 16 percent chance that the Fed will not cut rates again in 2025. While investor expectations have been moving in the right direction in recent months, the odds of a rate hike — which in my view is likely this year — are still being downplayed.

What could slow the economy? Trump’s erratic policy communication and, perhaps more importantly, his populist trade and immigration policies.

To be clear, much of what Trump hopes to achieve will strengthen the U.S. economy. As I wrote recently, the president’s approach to AI regulation and antitrust enforcement, and his desire to expand domestic energy production, reduce corporate taxes and roll back harmful regulations will boost growth. Investors largely agree — the S&P 500 has increased by around 6 percent since Trump’s victory in November.

But Trump has also sowed confusion about the future path of U.S. economic policy, particularly concerning trade. U.S. mergers and acquisitions were down nearly 30 percent in January 2025 compared to January 2024, reflecting this unpredictability. Consumers, too, are starting to show signs of nervousness. The University of Michigan’s index of consumer sentiment fell by 5 percent in February.

To be sure, since the pandemic, consumers have been as down on the economy as they typically are during recessions. But February’s decline in consumer sentiment seems to be related to inflation concerns. The Michigan survey showed a large month-on-month jump in median 12-month inflation expectations, from 3.3 percent to 4.3 percent. Notably, consumers in the Michigan survey were particularly gloomy about buying conditions for durable goods, which suggests anxiety about tariffs.

Research by economists Olivier Coibion, Yuriy Gorodnichenko and Michael Weber shows that Americans expect to pay nearly half of the costs of any tariffs that Trump enacts. And a different survey found that two-thirds of Americans do not think Trump is doing enough to lower consumer prices. Tariff fears and the potential for higher prices could lead consumers to cut back their spending, slowing the current expansion.

Women hold a sign at a hotel where migrants from Asia and the Middle East are housed after being deported to Panama as part of an agreement between the administration of U.S. President Donald Trump and the Central American nation, in Panama City, Panama, on Feb. 18. [REUTERS/YONHAP]

While the uncertainty caused by Trump’s erratic policy communication is harmful, following through on his populist policies would be much more damaging. Trump’s first-term trade war increased consumer prices and reduced business investment, manufacturing employment and competitiveness — without meaningfully cutting economic ties with China or lowering the trade deficit.

Goldman Sachs estimates that a sustained 25 percent tariff on imports from Canada and Mexico — which Trump announced on Feb. 1 but then almost immediately paused for 30 days — would reduce economic output by 0.4 percent. A study published by the Peterson Institute for International Economics finds that GDP will fall by 1.2 percent by 2028 if Trump deports 1.3 million illegal immigrants.

Trump was elected largely because voters rejected Joe Biden’s approach to economic policy, which had inflationary consequences. Given the U.S. economy’s underlying strength, Trump has begun his second term with the wind at his back. He should build on this advantage by pursuing his many policy goals that would boost growth, rather than those that would impede it.

Copyright: Project Syndicate, 2025.