Ethan Harris has had a long career as a noted macroeconomist. Early in his career he spent several years at the Federal Reserve Bank of New York heading the division of domestic research. He also worked as a leading economist at leading Wall Street financial institutions, like JP Morgan and Lehman Brothers including more than two decades as Bank of America’s Chief economist. He has ridden the economic waves through many cycles. He is as authoritative as any I have known.
When we talk about the latest inflation report for the month of February, which at first glance many saw as better than expected, the focus quickly shifts to - what else? - tariffs.
”So it's a bit of a surprise. Does that matter? Should markets really have reacted that much? Well, I think the problem for the markets is that they're, you know, dominated by tariff news. And so the CPI and in fact, the Fed itself is kind of a secondary story, frankly. As long as the the ups and downs of the tariff war keep popping up, you know, this was a little better than consensus expectations.'“
So dive in and hear what Ethan has to say. He starts by dissecting the CPI and why he sees sticky elements that will keep it from moving lower. And as a bonus he explains why the trimmed mean measure of inflation is the more modern, accurate gauge that he recommends which he says we can all benefit from using, too.
How do tariffs change the inflation game? “I think that increasingly it looks like the growth impact will be bigger than the inflation impact… raising the prospect of recession if the Trump team stays on this path.” Ethan is looking for the “Trump put” which is triggered “when there is enough pain to get them to back off.”
Inflation is high but not stuck 00:02:35.520
Those the numbers you just cited <CPI for February 2025>, it's consistent with this idea: that inflation is a bit high, but it isn't stuck. Maybe it, in fact, is still creeping down, and you give it, you know, 6 months or so maybe we'll be back to levels that the fed is fully comfortable with…. <But>if you look under the surface, though, there's a lot of weird stuff going on in this report, as there always is. And my take on it is that there's stickiness here that the fed still needs to be worried about.
Tariff news rules! 00:03:32.810
Well, I think the problem for the markets is that they're, you know, dominated by tariff news. And so the Cpi. And in fact, the fed itself is kind of a secondary story. Frankly, as long as the ups and downs of the tariff war keep popping up. This was a little better than consensus expectations. And so it was encouraging.
Core tried to identify a more stable inflation trend 00:04:24.410
The idea of a core measure of inflation where you take food and energy out came in 1975 in response to a period of massive commodity shocks in both food and energy sector. And so this was the birth of this indicator meant to take away all the volatility. So we can get a sense of, you know, beyond that noisy stuff.
Volatility masks trend, but it can be blunted 00:04:51.490
The problem is that over the years many other things create volatility in inflation. And so economists at the Fed and Cleveland, fed in particular, have developed indicators that remove noise, but don't base it on the category, but base it on the volatility. So they strip out all the crazy stuff. You know the used car price and the insurance numbers that are bouncing all over the map. They trim those out. and there's a concept known as the trimmed mean measure of inflation. That measure of inflation, unfortunately, was high. In February it rose at more than 3% annualized rate on the month.
Volatility OUT! Inflation still IN! 00:05:37.450
And if you look at these kind of measures that take out all the weird components. They're consistent with the idea that the Fed's having a really hard time. In this last mile battle against inflation. So I think we need to trim our enthusiasm
The Trimmed mean is a superior approach to find trend 00:07:00.220
The core measures should give you a better indication of what the underlying trend is and where we're heading. And the trim mean is just a far superior way to find that underlying trend than to just say, Okay, all food and energy out, no matter how volatile they are, we're taking them out.
Inflation war not won still being fought 00:09:17.550
But I think but stepping back, you know, beyond the technicalities and everything else, I mean, you really are an environment where the fed hasn't quite won the war on inflation. It's still a little bit high. Hopefully it unsticks and and comes back to target. But we haven't won yet. There's a lot of upside risks going forward.
The problem has been transferred to the service sector 00:10:23.850
Well, I think what you're seeing with inflation is that we know that a lot of the inflation was caused by shocks to the economy from the covid crisis and from commodity prices. Those are mainly goods, stories, and so goods, prices absolutely exploded and then slowed dramatically. So, in a sense, that area where the main story was about these shocks to the supply of product in the economy What's left is service inflation, service. Inflation is incredibly sensitive to labor, market wages and the expectations of inflation. If people believe in inflation, they'll tend to raise prices. If labor is expensive, they'll tend to raise prices. So that's where the stickiness is. What tariffs do is they take to the goods side which is looking great.
Goods and Service sector inflation both must behave 00:13:06.400
There is, you know, normally, service inflation is higher. Services don't have the high productivity gains, so wages tend to pass through to prices, whereas manufacturing has big productivity gains, and therefore chronically lower inflation. So you're really looking for both components and hoping that they both converge to normality and not just the good side.
House prices and housing inflation 00:14:00.560
You know. There are 2 ways to look at the housing inflation. One is. There are surveys that try to look at new rental rates, because remember, when they're measuring housing inflation, they're not measuring it, based on the cost of the price of your house, but on its rental value. If you look at rent data, it does look like rents have slowed down in many parts of the housing market. But the problem is, there's other evidence that you have a housing shortage. You know, you haven't had very low building in recent years. There's definitely many pockets of tight housing markets. So when you look at the shelter inflation story. It's a little different than you know talking about hot labor market or commodities, or all that. It's about the physical shortage in the market, and that's why shelter costs haven't really come down enough.
Tariffs, uncertainty, Stagflation? 00:16:08.171
A kind of stagflation? It tends to hurt you on both fronts. Here's the thing with the trump tariffs. I'm beginning to change my view on this. I think that increasingly it looks like the growth impact will be bigger than the inflation impact. And the reason I say that is it's not. They're not just imposing tariffs. They're creating massive uncertainty. When you're uncertain. You tend to become conservative in your spending. And then on the corporate side, initially, the corporate sector confidence went up significantly with the election.
Is the “big Story’Changing? 00:17:29.130
There was a lot of hope that the big story of the day was corporate tax cuts, deregulation, right? That's good news for the corporate sector. And so Ceos and small business leaders, all became very optimistic about the outlook that is now steadily eroding. And so, if you again, if you look at surveys in recent weeks, you know. Well, into the trade war. They're all falling. And so it's the confidence shock that may end up being the big story of the day, not the actual tariff in itself, which creates problems on its own.
Recession risk depends a lot on the President and his view 00:19:05.370
My own view is that we're going to just get an extremely weak period of growth ahead. That's assuming that trump isn't a hundred percent serious, that he doesn't care about the near-term picture. If he's serious. If he really thinks that all of this stuff we're seeing now the kind of signs of pain emerging should be ignored, including the sell off in the equity market. If he decides that that is irrelevant, because there's a Golden age coming a year from now, and everyone will forget this by the time of the midterms, if that's what he thinks. Then I think we get a recession, because the path we're heading on now of tit for tat trade war ever tougher rules around trying to round up.
Trump Put? 00:19:25.120
All of this stuff we're seeing now the kind of signs of pain emerging should be ignored, including the selloff in the equity market. If he decides that that is irrelevant, because there's a Golden age coming a year from now, and everyone will forget this by the time of the midterms, if that's what he thinks. Then I think we get a recession, because the the path we're heading on now of tit for tat trade war ever tougher rules around trying to round up undocumented immigrants, or at least scare them out of the labor market. All this stuff around freezing government spending and then reinstating it, but maybe not reinstating it. All of that stuff. If you keep at the pace you've gone in the last couple months. It's like begging for a recession. So we need to. I'm looking for the trump put when does? When is there enough pain to get them to back-off?
No quick fix or transformation 00:22:04.430
It is important to understand here this idea that you impose a brief period of pain, and then you're off to a golden age. I don't know any economist outside of the Administration that actually believes that you go to a new world of tariff trade barriers, and if you shrink the labor force by pushing as many people as possible out of the country. the damage to the economy will go beyond the next year it'll be. There'll be a permanent scar to the economy.
Trump offers a complicated process 00:24:24.770
I think there are elements of a lot of his policies that make sense. I mean, we could go down the list right should our allies spend more on defense? I think they should. The Us. Has had too much of a burden. Should we control our borders more effectively on both fentanyl and undocumented immigrants. Absolutely do we want to get make sure that undocumented immigrants are not that we don't have criminals in our country that need to be deported. But to do a mass deportation campaign. That is a very disruptive thing. Let's not forget that the reason we have so many immigrants in the US. Is not because they're here to collect social security or Medicaid. They're here to work right? The immigrants work more immigrants work than Americans as a share of the population, and they commit fewer crimes than Americans. So they're here to work.
A contrived crisis on the Northern border? 00:26:03.720
Those are a crisis on your Southern border, not on your northern border. What can we possibly do to help you out? We have the same problem as you do. We don't want Fentanyl, we're not. There's very little Fentanyl going from the Us. Into the from Canada into the Us. And there are more undocumented immigrants crossing into Canada than the other way around, so there's nothing they can do to fix it. And then you tell them we want you to be the 51st State. Right? So what? What does the average Canadian citizen think of this? They are outraged. No Canadian politician can afford to not retaliate, they have to retaliate. So he's painted both the Mexican Government and the Canadian Government into a corner where they have to retaliate, and he's doing the same thing with Europe. He's instead of approaching them with an idea that he really wants a deal with them. He keeps insulting them
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