3. Tax cuts risk fueling too much demand – and price hikes
Economists are also worried about the inflationary impact of tax cuts.
Trump’s tax plans include extending the trillions of dollars in cuts his administration signed into law in his first term – most of which are set to expire in 2025 – and eliminating or reducing other taxes.
While cutting taxes can temporarily boost disposable income by increasing the money households have on hand, it can also drive up inflation by increasing what economists call “aggregate demand” – that is, the total demand for goods and services across the economy.
When this rises sharply, it can put pressure on prices, especially if the supply of goods and services can’t keep up. This imbalance risks fueling inflation, as businesses raise prices to keep up with the surge in demand.
This dynamic is similar to what we observed after the COVID-19 pandemic, when pent-up desire to buy goods and services — built up after months of lockdowns and restrictions — was unleashed. Households, eager to spend, drove up demand in areas like travel, dining and consumer goods.
But businesses faced challenges: supply chain disruptions, labor shortages and limited production capacity. With demand outpacing supply, inflation soared as prices spiked in many sectors.
Could the ‘inflation nightmare’ return?
Expectations that inflation is once again on the rise could have another result that would be painful for consumers: higher interest rates.
The pace of inflation came down from about 9% in the summer of 2022 to 2.4% in September 2024 after the Fed began aggressively hiking its benchmark interest rate. By driving up borrowing costs on everything from car loans to mortgages, the Fed forced many consumers to cut back on spending and priced many Americans out of the housing market.
The drop in inflation, coupled with concerns about the strength of the economy, prompted the central bank to switch course a few months ago and cut rates twice by a total of 0.75 of a percentage point, bringing some relief to consumers. But if the Fed believes inflation is headed higher due to these new policies, it may have to reverse course again and raise rates to fight it.
This, of course, would make it harder for Americans to afford a home – especially when coupled with a labor shortage in the construction industry.
Taken together, many of Trump’s proposed policies may inadvertently fuel another “inflation nightmare.”
Veronika Dolar, Associate Professor of Economics, Pace University
This article is republished from The Conversation under a Creative Commons license. Read the original article.