Tariffs
A tariff is defined by Investopedia as “a tax imposed by one country on the goods and services imported from another country.” The benefits and drawbacks of using tariffs have been debated for centuries. On August 1st, President Trump signaled that he would hike tariffs on Chinese imports in August after talks failed to deliver a trade deal. According to U.S.A. Today, the threatened tariffs amounted to a 25% tariff (or tax) on $250 billion in Chinese imports plus a 10% tariff on $300 billion in additional goods.
Tariffs have been used in trade wars throughout history in an attempt to impact a competitor country’s economy or to protect businesses in the home country. President Trump is initiating tariffs based on the attempt to push American consumers to favor goods made in America versus goods made in China.
Markets have been reacting negatively to these tariff threats due to fear that it could lead to higher prices for American consumers because they would not have access to lower-cost Chinese goods or would have to pay more for the same goods. Additionally, there is historical evidence that less competition for goods can lead to lower efficiency and higher prices in general. Although tariffs may help American businesses sell goods, this environment could lead to slower economic growth with less consumer buying activity.
Interest Rates
The FOMC is a U.S. committee designed to act on its congressional mandate to promote maximum employment, stable prices and moderate long-term interest rates in the U.S. economy. The primary tool it utilizes at this time is the Fed Funds Rate, which is a target rate at which depository institutions lend reserve balances to other depository institutions overnight. This overnight lending activity is key to the functioning of our banking and lending systems across the U.S.
This lending rate affects banking institutions and in turn affects the rate at which lenders are willing to lend money to businesses and consumers. The lower the interest rate, the more desirable lending activity will be for businesses and individuals. To help ease economic activity and promote lending surrounding the financial crises, the FOMC lowered interest rates over time from 5.25% on September 18, 2007, to 0.0% on December 16, 2008. On December 17, 2015, the FOMC began slowly increasing the rate until its recent peak of 2.5% on December 20, 2018.
In 2019, the Fed Funds Rate target has been lowered twice and now sits at a target range of 1.75-2.00%. By lowering the rate, the committee is seeking to stave off negative effects of a slowdown in corporate earnings growth and the impact of potential tariffs by promoting lending activity and access to lower cost funds.
Tariffs and Interest Rates Working Together
Interestingly, the combination of tariffs and the Federal Funds Rate is important. The competitive market for American goods and access to affordable lending can help American businesses maintain their employees and seek additional opportunities to expand. Consumer demand remains strong, aided by an extremely low unemployment rate and improving productivity at U.S. businesses. Every little input can matter to future growth, and tariffs and interest rates are no exception.