I confess: I am a huge fan of Victor Davis Hanson (VDH). But I do wish he’d follow a promise made in a podcast, namely that he avoided talking about subjects with which he had no expertise. Economics is one of those subjects. Sit down and relax. This is my diatribe on economic illiteracy and the chattering classes.
The latest example of VDH getting out over his skis is his appearance on the Megyn Kelly show July 29. VDH is talking about Fed Chair Jerome Powell’s refusal to lower interest rates in response to President Trump’s demands. Here’s the interesting quote (VDH speaking):
All Trump is trying to say is, if you use the same calculus that you did during the Biden administration, where, when, after all, before the election, they lowered interest rates. If you just cut it by a third, we would save another third of a trillion dollars. That’s, you know, 60 that’s about $700 billion in interest savings and tariffs and were a third of the way to balancing the budget.
For reference, here’s the cut President Trump is talking about. The second graph gives a longer-term perspective.[1]
Fig01 Federal Funds rate August 2024 – June 2025. (click for larger image)
Fig02 Fig01 Federal Funds rate 2010 – 2025. (click for larger image)
This, of course, completely ignores the macroeconomic state of the economy — not to mention its future state. The economy today is not in the same shape it was in August, 2024.
This is really about tariffs. President Trump loves them. He has already imposed 15% tariffs on most of the world. China gets a pass because these tariffs are based on the whim and wishes of the President. The note below is unverified, but would not surprise anyone if it was real.
Fig05
The Economics of Tariffs
Someone has to pay a tariff. In practice, the group that actually ponies up the cash first is importers. But I promise they will not eat the tariff. They will increase the price they charge for their products.[2] Those who argue this will not happen are ignoring centuries of economic theory and empirical tests of the theories. Here’s a graph.
Fig03 How a Tariff Works part 1. Click for larger image. From Jeffrey Perloff, “Microeconomics: Theory and Applications With Calculus” (3e), pp. 312-313. Pearson, 2014. Copyright Pearson Education Inc. All Rights Reserved. Published here under educational fair use provisions of U.S. copyright law.
Fig04 How a Tariff Works part 2. Click for larger image. From Jeffrey Perloff, “Microeconomics: Theory and Applications With Calculus” (3e), pp. 312-313. Pearson, 2014. Copyright Pearson Education Inc. All Rights Reserved. Published here under educational fair use provisions of U.S. copyright law.
(Math included to keep my readers with econ degrees happy.)
President Trump is also very concerned with the balance of trade deficit. Curiously, he is currently pressuring the European Union to invest more in the U.S. In several previous articles I’ve discussed the relationship between the balance of trade and the balance on financial accounts (here and here). Basically, a trade deficit must be offset by an equal financial account surplus. If Europe invests in the U.S., by definition this will be balanced by a larger deficit in the trade account.
In other words, the economic messages conveyed by this administration are both confused and confusing. Not to mention self-contradictory. I urge the Fed to continue their stubborn resistance to pressure from all sides – including, but not limited to, the executive and legislative branches of the U.S. government.
Conclusion
For reference, here’s my recording of the relevant part of Megyn Kelly’s show.
And here’s the link to download the usual Excel workbook. Also the link to download my transcript of the audio.
I recommend Dr. Hanson stay in his lane.
- The Federal Funds Rate is the interest rate on overnight loans between Fed member banks. The banks are lending and borrowing reserves. Since the Fed can control the quantity of reserves in the system, they can, in principle, control the Federal Funds rate. I’ll be the first to say that monetary policy today bears little resemblance to this description, but the idea is pretty much the same. That’s why the Fed uses the Federal Funds Rate as the policy target. ↑
- The product price will not increase by the full amount of the tariff. The reason is our old pal, the first law of demand. Higher price means lower quantity purchased. In perfectly competitive markets, the new long-run equilibrium will pass 100% of the tariff to buyers. But that will cause a decrease in quantity demanded, leading to lower output per firm and/or fewer firms in the industry. In imperfectly competitive markets, the decrease in quantity demanded occurs much faster as the each seller faces a downward-sloping demand curve. The demand curve causes reduced quantity demanded immediately. ↑
