The Hutchins Roundup brings the latest thinking in fiscal and monetary policy to your inbox. Have something you'd like us to include in the next Roundup? Email us and we'll take a look.
This edition was written by Sarah Ahmad, Tristan Loa, Andrew Rosin, and Louise Sheiner.
After a three-year pandemic-induced pause, federal student loan repayments for 40 million Americans resumed in October 2023. Using ZIP-code-level transactions data that cover 55 million individuals, Aditya Aladangady and co-authors from the Federal Reserve Board find that, following the June 2023 announcement that payments would restart, households reduced their weekly spending by $6.20 for every $10,000 of student debt they held. This reduction nearly doubled to $12.20 per week after payments resumed in October. The authors estimate that the resumption of student loan payments reduced aggregate demand by approximately $80 billion at an annual rate. This reduction represented about 0.3% of GDP in the first quarter of 2024, demonstrating that the end of student loan forbearance—or its removal—had a meaningful impact on aggregate demand.
What effect do tariffs have on the natural rate of interest (the rate expected to prevail when the economy is at full employment with stable prices, a key benchmark for central banks)? Neil Mehrotra and Michael E. Waugh of the Federal Reserve Bank of Minneapolis argue that in the short run, tariffs reduce firms’ demand for capital by raising the relative price of investment. Because the supply of assets remains unchanged, the natural rate of interest declines. But in the long run, as tariffs reduce GDP and household income, household savings decline about as much as demand for capital, and the natural rate returns to its pre-tariff level. The authors simulate two scenarios: a unilateral 15% tariff imposed by the U.S. and a trade war in which the European Union and China retaliate and impose 15% tariffs on imports from the U.S. In both the unilateral tariff and global trade war simulations, the natural rate of interest falls considerably in the short run—by 30 basis points and 50 basis points, respectively—suggesting that central bankers should lower interest rates to maintain stable prices and full employment. In the long run (about five years later in these scenarios), the natural rate of interest returns to its original level, but GDP is about 1% lower under the unilateral tariff and about 1.5% lower under the trade war.
Eric Budish of the University of Chicago and co-authors develop a model identifying conditions under which missing markets for innovation—when inventions are at risk for immediate imitation because they lack enforceable intellectual-property (IP) rights—eliminate incentives for research and development. Focusing on research into new therapeutic uses for existing drugs, where enforceability of IP rights changes sharply when patents expire, they find that private investment and commercialization nearly cease when IP rights become unenforceable. The authors estimate that enforceable IP rights on new drug uses would generate between 0.1 and 0.4 additional new uses per drug. Applied to the roughly 2,000 drugs approved since 1962, this implies between 200 and 800 more new uses would have been developed under stronger IP policies. The social cost of this missing innovation is estimated to be between $2.5 trillion to $10 trillion since 1962. More broadly, the research shows that “stronger intellectual property protection does, in fact, induce investment, and that heterogeneity in the availability of these rights distorts investment.”
"The big story here, of course, is tariffs. There are clear signs that tariff increases are affecting consumer prices and that trade diversion is taking place. One area where we can clearly see the initial effects of tariff increases is in core goods prices. Price increases for items that are exposed to higher tariffs have been well above what one would expect based on past trends and in the absence of tariffs," says John C. Williams, president and chief executive officer of the Federal Reserve Bank of New York.
"The realized aggregate effects of tariffs so far have not been as large as expected earlier in the year, but it’s still early days, and it will take time for them to come to be fully realized. Combining enacted and announced tariffs, estimates of the average effective tariff rate range between 15% and 20%. By comparison, net tariff receipts as a share of imports rose from about 2-1/4% in the first three months of the year to around 10% in July. This is a sizable increase for sure, but well short of the increase implied by a straight read of the announced tariffs.
Fortunately, I am not seeing signs of amplification or second-round effects of tariffs on broader inflation trends. In particular, recent readings of the New York Fed’s
Global Supply Chain Pressure Index are near historical averages. And longer-run inflation expectations have remained stable, while short- and medium-term inflation expectations, after increasing modestly earlier in the year, have returned to their pre-pandemic ranges. This is critically important, because well-anchored inflation expectations are essential for sustained price stability.
All in all, I expect tariffs will boost overall prices by a total of between 1 and 1-1/2%, with these effects continuing through the first half of next year. That’s my current estimate, but there is a great deal of uncertainty about these effects. As we collect more data, we will get a better understanding of the magnitude and timing of tariffs’ effects. I’ll continue to monitor prices and broad movements in inflation over time to assess evolving conditions."
