Post from First Trust Economics Blog

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist 

April 14th, 2025

Quantitative Easing was different during COVID than

during the Financial Panic of 2008. During COVID, M2 growth

soared, while it was held back during the Financial Panic by

much tighter liquidity controls on banks. That’s why we were

among the first and very few who predicted much higher

inflation due to COVID policies.

After that, we remained wary of loosening monetary policy

too aggressively because we feared that, in spite of a drop in

inflation, inflation remained above the Federal Reserve’s 2.0%

target and the embers of higher inflation could be rekindled

quickly if the Fed were too hasty.

But recent inflation reports suggest some modest room for

loosening monetary policy, including a reduction in short-term

interest rates. In spite of some new tariffs, consumer prices

declined 0.1% in March, the largest decline for any month since

the early days of COVID. As a result, consumer prices were up

only 2.4% in March versus a year ago and it looks like the Fed’s

preferred measure (PCE prices) is up about 2.2% in March

compared to a year ago, which is very close to the 2.0% target.

Yes, we are still above 2.0%, but monetary policy operates

with long and variable lags. So, if we maintain a monetary policy

tight enough to bring inflation down to 2.0%, and if we also wait

until inflation hits 2.0% before ending that tighter monetary

regime, then we are almost guaranteeing that inflation will fall

short of that 2.0% target for some period of time and could raise

medium-term recession risk.

The same M2 measure of money that signaled high inflation

several years ago is only up 3.9% in the past year. By contrast,

M2 grew at about a 6.0% annual rate in the ten years before

COVID, and that was during a period when PCE inflation

averaged 1.5% per year. In other words, there’s a case to be

made that monetary policy should be looser so that M2 could

grow faster than it has in the past year.

Unlike some other analysts and investors, we are not

concerned that tariffs will lead to much higher inflation, as

inflation ultimately depends on monetary policy, not tariff or tax

rates. Yes, tariffs could increase the price of the particular items

being tariffed. But that means less money would be left over to

buy other goods and services, so demand – and prices – typically

fall, leaving the overall price level roughly the same as it would

be in the absence of tariffs.

However, tariffs could temporarily depress economic

growth as they leave consumers and businesses with less to spend

on domestically produced goods and services. In theory, tariffs

mean producers should shift some of their output toward being

made in the US, but in the short-term businesses may balk at such

a shift if they think the tariffs will just be repealed soon anyhow.

In other words, if we are going to impose tariffs, it’s better to

impose a tariff system that’s sustainable than one that changes

year to year, much less week to week or day to day.

On balance, that suggests some modest room for the Fed to

cut short-term rates when it meets in May, although we think the

Fed will probably kick the can down the road and make the

decision in June.

Don’t get us wrong; we are not changing our view that

inflation remains a long-term problem that the Fed must be

prepared to fight. We expect inflation to average 2.5%+ in the

next ten years, not the 1.5% like it did pre-COVID. But short-

term risks are to the downside, and we think the Fed should

temporarily focus on that.

We also think it’s important for the Fed to move gradually.

The US dollar has weakened lately, and, as a result, there is little

case for a drastic loosening of monetary policy. The Fed could

let up somewhat on bank regulations and capital requirements,

which would help the struggling bond market. And one or two

rate cuts would not be excessive.