Work & Economy
Where next for U.S. economy?

Richard Drew/AP

Christina Pazzanese

Harvard Staff Writer

March 18, 2025 6 min read

Kennedy School analyst’s recession warning includes worries about trade war, stock market, risk perception

U.S. markets this month suffered heavy losses after China, Mexico, and Canada responded to President Donald Trump’s tariff push by imposing levies on American goods. Many investors fear a prolonged trade war could push the nation into a recession. (The president says that Americans should expect a “period of transition.”) Meanwhile, the University of Michigan’s consumer sentiment index has fallen to its lowest level since November 2022.

These developments serve as a backdrop for meetings this week where the Federal Reserve will weigh whether to resume interest rate cuts.

In this edited conversation, economist Jeffrey Frankel, James W. Harpel Professor of Capital Formation and Growth at Harvard Kennedy School, discusses the impact of the new administration’s tariff policy and the broader condition of the U.S. economy.

Jeffrey Frankel.

Harvard file photo

Is there a good argument for increasing or expanding tariffs?

They’re pretty universally bad — almost all economists are opposed to them. Can there ever be a good justification for a tariff? Three cases I can think of. First, a poor country may have no effective way of collecting revenue other than a tariff. Second, there’s a so-called “infant industry” argument — that if government is able to identify an industry that has potential for economies of scale and spillover effects, they need to protect it against international competition for a few years and then the industry will grow, and the government will be able to remove the tariffs and have it compete on world markets. Third, the Europeans have something called CBAM, Carbon Border Adjustment Mechanism, in the cause of fighting climate change. One might interpret that as a tariff, but my interpretation is that because it helps carry out the Paris Accord, it may be beneficial and indeed is the sort of measure that is fine under the World Trade Organization. There are probably other examples, but none that apply to the U.S. today.

Treasury Secretary Scott Bessent called the market selloff a “normal” and “healthy correction” to years of overreliance on government spending, predicting that we’ll end up with a stronger economy. Is that a plausible explanation?

It’s not based on anything. Their way of coping is to stall for time, saying, “Well, of course, we’re going to have some negative effects at first, but this prosperity will come after.” But that’s not based on any kind of economic argument that I have heard, let alone a valid one.

I suppose someone could argue that with tariff protection, our manufacturing sector will achieve higher investment and higher productivity growth, and we’ll be more competitive in the long run, and that higher growth will show up in higher incomes. But the Trump approach to tariffs is hurting investment, not helping it. Usually what they say is that boosts confidence, but the current policy chaos is having the opposite effect. It’s reducing confidence.

For countries undergoing debt crises, mainly developing countries, a common pattern is that they’ve been running budget deficits that are too large, and their debt level is getting too high. Then, as part of an adjustment program, usually under the guidance of the IMF [International Monetary Fund], they have to undergo a combination of reducing the budget deficit, monetary discipline, and devaluation. That causes a year or two of severe economic pain but allows a recovery subsequently and a restoration of growth in the long-term. You could characterize Korea in ’98 that way, for example. The excessive debt part of the pattern does describe the U.S. now, but I don’t think the rest applies to the U.S. A debt crisis is not to be recommended and is not what the tariff proponents have in mind.

The latest University of Michigan consumer sentiment index shows economic confidence is at its lowest since November 2022. Also, hiring has cooled . Do these developments point to a recession or something like 1970s-style stagflation?

I think it is appropriate to worry about a recession coming within the next year. It’s much more likely than one would have thought a year ago.

I see five things going on that could logically lead to or worsen a recession. One is the trade war. The second is a stock market crash. The third is major cuts in government spending, assuming Musk and Trump manage to find genuine cuts. The fourth is a U.S. fiscal crisis because of a government shutdown, failure to raise the debt ceiling, or a downgrading by Moody’s, the credit rating agency. The fifth is a general increase in perceptions of risk. Risk is increasing because what Trump has done on tariffs and on government spending has been so erratic. It’s almost as if they’re doing everything they can to increase perceptions of variability and volatility and unpredictability. The uncertainty itself has a negative effect.

The instability has alarmed not just investors, but also sectors like real estate and health care, with many businesses shifting into “wait and see” mode. What are the implications for the wider economy?

If the uncertainty only lasted a minute, it wouldn’t have much effect, but it’s clearly going to last longer than that. Even if it takes a few months to resolve these issues, that could be enough to hurt employment and income and even to cause a recession. In the extreme, if all hiring stops for a month or two, that itself would cause a recession.

The Federal Reserve faces two seemingly contradictory options on interest rates: support the economy and jobs with rate cuts or leave them alone to keep inflation and inflation expectations under control. What’s the Fed likely do?

That’s the tradeoff. In a sense, it’s always the tradeoff, but it becomes much more acute at a time like this, because tariffs and general chaos are adverse supply shocks. They’re like a world oil shock or a COVID shock or something like that. Supply shocks make a tradeoff between output and inflation worse, and they’re not something the central bank can make up for. So, the Fed is worried both about increasing inflation and about a slowdown in the economy. One objective says keep interest rates higher, and the other says cut them. I think they will leave them unchanged.