At a recent press conference, Federal Reserve Chair Jerome Powell claimed that the Fed’s flexible average inflation targeting (FAIT) framework did not contribute to the post-pandemic inflation surge. 

There was nothing moderate about the overshoot. It was — it was an exogenous event. It was the pandemic and it happened and, you know, our framework permitted us to act quite vigorously. And we did once we decided that that’s what we should do. The framework had really nothing to do with the decision to — we looked at the inflation as — as transitory and — right up to the point where the data turned against that. — and when the data turned against that in late ‘21, we changed our — our view and we raised rates a lot. And here we are at 4.1 percent unemployment and inflation way down. But the framework was — was more — was more irrelevant than anything else that — the that part of it — that part of it was irrelevant. The rest of the framework worked just fine as — as we used it — as it supported what we did to bring inflation down.

The temporary rise in inflation and permanent rise in the price level was, according to Powell, beyond the Fed’s control. The Fed’s framework did not inhibit the Fed’s response. To the contrary, Powell said, the framework supported the Fed’s efforts to rein in inflation.

There’s no subtle way to put this: Powell’s account of what happened is incorrect.

Let’s start with the rise in prices. While the price level initially declined below the Fed’s two-percent target when the pandemic hit, it quickly recovered. By March 2021, the overall level of prices had returned to the two-percent growth path. It then rose rapidly until the Fed aggressively tightened monetary policy midway through 2022.

In his recent remarks, Powell describes the rise in prices as “exogenous,” suggesting that it had nothing to do with monetary policy. It is unclear what he means here, but one interpretation is that he is blaming inflation on pandemic-driven supply constraints. 

There are several problems with this view. For one, the timing does not make any sense. The worst of the pandemic-induced supply constraints occurred in 2020. The economy had largely recovered from these constraints by the time inflation picked up in late 2021.

Moreover, a temporary reduction in real output, on its own, would not result in a permanent rise in the price level. Absent an increase in nominal spending, the price level would have fallen as real output recovered. That, of course, is not what happened. Real GDP has basically returned to trend, yet the price level remains substantially higher than it would have been had the Fed hit its two-percent inflation target over the past few years.

So what caused the rise in prices? 

The short answer is that the Fed’s response to the pandemic resulted in a surge in nominal spending. Mistaking this positive aggregate demand shock for a negative aggregate supply shock, the Fed initially delayed its response. As Powell admits, it is only after “the data turned against that” view that the Fed changed course.

But even that is too charitable. The Fed did eventually change course, but it did not do so right after the data turned against the transitory supply-side story in the back half of 2021, as Powell suggests.

By the time the Fed released its projections in December 2021, Fed officials had access to inflation data through October, which showed inflation had averaged 5.8 percent year-to-date. But the December median inflation projection for 2021 was just 5.3 percent. For that forecast to be accurate, inflation would have needed to average just 2.7 percent in November and December — a sharp decline from the preceding trend. Moreover, Fed officials made no changes to monetary policy at the December meeting, nor did the December median federal funds rate projection for 2021 shift from prior meetings.

In short, it seems as though they expected inflation to fall in the final months of 2021 without any policy tightening — suggesting they still attributed inflation to transitory, pandemic-related supply constraints, despite Powell retiring the term at the end of November.

Fed officials did not act swiftly and decisively once they realized the problem in late 2021, as Powell claims. They did not even begin to raise the federal funds rate target until March 2022 — at least five months after the data revealed a demand-side problem and three months after Fed officials acknowledged that problem. Even then, the Fed officials proceeded slowly, despite inflation surging past their projections during the early months of 2022. Indeed, the real federal funds rate would remain negative until June 2022! It was not until July 2022 that Fed officials finally got serious about getting inflation under control. They raised the federal funds rate target by 75 basis points, and then followed up with several substantial rate hikes throughout the remainder of 2022 and early 2023.

The Fed’s slow response to the surge in aggregate demand pushed the price level well above its pre-pandemic growth path. 

Where does the Fed’s FAIT framework come into play? Under FAIT, the Fed targets inflation asymmetrically: it only makes up for inflation undershoots. It does not make up for periods when inflation averages more than 2 percent. Consequently, the price level will not return to its pre-pandemic growth path. That is not an accident. It is the direct result of the Fed’s FAIT framework. 

Contrary to Powell’s claims, FAIT is far from irrelevant. It explains why the price level, having grown faster than the Fed had hoped, will now remain permanently elevated despite the Fed’s aggressive rate hikes. Perhaps that’s what Fed officials wanted. Perhaps they would not have done anything differently had they not been constrained by FAIT. If that’s the case, they should say that. The fact is, given the Fed’s adherence to its FAIT framework, they were not able to do anything other than permit the price level to remain permanently elevated.  

Getting this history right matters. If Fed officials are going to avoid making similar mistakes in the future, they must take responsibility for their role in driving prices permanently higher. As Fed officials review their framework this year, they should keep the following in mind: either FAIT enabled the price level to rise permanently higher beginning in 2021 or failed to prevent it from rising permanently higher. Either way, it needs to go.

The Trump administration’s announcements of a 10 percent tariff on Chinese imports and 25 percent tariffs on goods from Mexico and Canada (all currently in some holding pattern) have led to considerable volatility in stock and foreign exchange markets. 

Investors, unsurprisingly, are expressing concerns over potential disruptions in global supply chains and the macroeconomic implications of obstructions to trade. But interestingly, various financial markets have shown a relatively muted response to proposals regarding the implementation of reciprocal tariffs. The subdued character of the reaction may simply show exhaustion, with market participants becoming desensitized to new announcements. Or, the quiescence could indicate that investors are nonplussed, perceiving reciprocal tariffs as less impactful, likely to be negotiated away before implementation, or even positive. 

By way of explanation, reciprocal tariffs are trade duties that a country imposes to mirror the tariffs placed on its exports by another nation. The primary objective is to either establish a level playing field or retaliate, ensuring that if one country levies tariffs on certain goods, the affected nation can respond with equivalent tariffs. For instance, if Country A imposes a 20 percent tariff on steel imports from Country B, Country B might retaliate by enacting a similar tariff on steel or comparable goods from Country A. The strategy behind reciprocal tariffs is to incentivize countries to reduce or even eliminate trade barriers, fostering a more open and balanced international trading system.

Several nations currently impose tariffs on US goods without facing equivalent tariffs, or impose tariffs of a much higher magnitude on goods imported from the United States. India, for example, has been identified as maintaining high tariffs on many American products, with average rates around 17 percent: significantly higher than the US rate of 3.3 percent on some Indian products. Similarly, the European Union applies a 10 percent tariff on US automobiles; the US has its own tariffs on European cars, but at a much lower rate (2.5 percent).

A foundational distinction in economics is that which separates positive analysis (describing the world as it is) from normative analysis (prescribing how it should be). Reciprocal tariffs provide a particularly useful lens through which to examine this dichotomy. While economic theory generally favors free trade as the optimal state of global commerce, real-world policy decisions tend to reflect a more interventionist approach. Specifically, the question of whether a nation should respond to foreign tariffs with its own protectionist measures exemplifies this ongoing debate. 

Reciprocal tariffs illustrate the divide between positive and normative economics: a positive analysis explains that while unilateral free trade generates benefits for consumers and economic efficiency, imposing reciprocal tariffs can pressure protectionist nations to lower their trade barriers, potentially leading to freer trade overall. The normative question, however, is whether a nation ought to take the principled high ground by avoiding retaliatory tariffs or instead strategically impose them to achieve long-term trade liberalization.

On one hand, a nation may determine that the most economically sound response to tariffs on its goods is not to impose retaliatory tariffs of its own. Free trade tends to maximize efficiency by allowing nations to specialize in the production of goods and services in which they have a comparative advantage. Retaliatory tariffs, by contrast, restrict trade, increase costs for consumers, and distort resource allocation. 

US Trade Policy Uncertainty Index (1990 – present)(Source: Bloomberg Finance, LP)

Even when one country implements tariffs, unilateral free trade remains beneficial. Avoiding counter-tariffs keeps domestic prices lower, benefiting consumers and businesses reliant on imported goods. Not retaliating also prevents damaging trade wars, which have historically had negative economic consequences (consider the Smoot-Hawley Tariff Act, which exacerbated the Great Depression). In addition, there is the not-inconsiderable moral high ground: a nation committed to unilateral free trade can position itself as a stable, open-market economy, attracting investment and diplomatic goodwill. From this perspective, free trade is the ideal arrangement regardless of how other nations act.

There is an alternative argument, which holds that reciprocally tariffing nations that impose or maintain tariffs may serve the broader cause of freer and more productive trade in the long run. While imposing tariffs is contrary to free-market principles, strategic reciprocation may pressure protectionist nations to lower or eliminate their trade barriers, leading to a more open global system. The practice of imposing reciprocal tariffs is not without risk, but may force protectionist governments to reassess the costs of obstruction, possibly resulting in broader trade liberalization. In that sense, reciprocal tariffs may be viewed as a corrective measure as opposed to an end goal. Proponents of doing so are likely to characterize reciprocal tariff campaigns (such as that which is being discussed) as pragmatic, free-market oriented interventions as opposed to dogmatic non-interventionism.

But imposing retaliatory tariffs, even if undertaken in the spirit of fostering unfettered trade, is a perilous proposition. History shows that such measures may escalate trade disputes, disrupt supply chains, and inflict disproportionate harm on domestic consumers and producers. While foreign tariffs hinder US exports, raising domestic barriers in response may encounter intransigence, compounding inefficiencies and weakening economic stability. Additionally, their targeting is inherently political in nature. The prosperity of the United States ultimately depends not on mirroring the protectionism of others but on maintaining open markets and competitive pricing. Imposing reciprocal tariffs, would represent a further deviation from the general historical principle of the US applying unconditional Most-Favored-Nation (MFN) trading policies outside of bilateral and regional agreements. 

(Two such deviations have occurred recently: Biden’s 2022 revoking of Russia’s and Belarus’s MFN status to impose higher tariffs in the wake of the invasion of Ukraine, and the tariffs imposed by the Trump administration on Chinese imports during beginning in 2018.) 

The debate over reciprocal tariffs underscores the is/ought dichotomy that is central to economic policy analysis. Free trade is the optimal outcome, and unilateral free trade remains beneficial even in the face of foreign tariffs. In the government/official sphere, though, trade dynamics may be deemed as necessitating strategic responses to protectionist policies abroad. But dismissing, let alone praising, tariff threats of any kind (retaliatory or other) as “negotiating tactics” ignores the creation of market distortions through preemptive stockpiling, increased costs due to administrative and compliance changes, and growth-impeding uncertainty, which delays investment and expansion decisions.

Navigating between the science of economics and the practical realities of real-world decision-making is a perpetual challenge. The debate over the application of reciprocal tariffs illustrates a broader truth pertaining to all of the social sciences: sound economic theory provides guiding principles, while real-world application, especially when political dynamics enter the fray, frequently requires balancing normative ideals with unsentimental practicality. 

As a scientist, I would prefer the theoretically sound, apolitical (and principled) approach, but the debate presents a valuable opportunity to highlight the contrast between idealism and expedience: in trade policy, and beyond.

On Sunday, Germany’s voters will elect a new government. Polls indicate that the once mighty Social Democratic Party (SDP) will be reduced to fighting the Greens for third place while the right-wing Alternative for Germany (AFD) will finish second behind the more “moderate” Christian Democrats (CDU). With the war in Ukraine at a turning point, the result matters beyond Germany, and even Vice President J.D. Vance has found himself caught up in the campaign.    

The proximate cause of Sunday’s election is the collapse of the governing coalition of the SPD, Greens, and free-market Free Democratic Party (FDP) following disputes over economic policy. The ultimate causes are several, and a leading one is Germany’s stagnant economy. It offers a stark warning to the United States and any country tempted to sacrifice its economy in pursuit of “green dreams.”   

Green Dreams 

Until recently, this would have seemed incredible. In the early 1990s, Germany’s per capita Gross Domestic Product (GDP), adjusted for inflation and differences in living costs, was equal to that of the United States, an incredible achievement for a country whose economy was obliterated during World War II. The jewel in West Germany’s economic crown was its manufacturing sector, which specialized in high-quality products made by a highly capitalized, highly productive, highly paid workforce. This accounted for 19.9 percent of German GDP in 1997 compared to 16.1 percent in the United States: By 2021, while manufacturing had fallen to 10.5 percent of United States’ GDP, it still accounted for 18.7 percent in Germany.  

The absorption of East Germany, historically poorer than the west and relatively impoverished further by decades of communism, was a strain, and German per capita GDP reached near parity with France and Britain by the mid-2000s. Then its relative performance improved thanks to the introduction of a currency shared with weaker economies like Greece and Italy which dragged the foreign currency price of German exports down. By 2020, Germany’s per capita GDP was about $12,000 to $10,000 higher than that of France or Britain.  

But German policymakers were determined to fight climate change; indeed, they opposed not only fossil fuels but anything that wasn’t wind or solar. In 2011, Chancellor Angela Merkel (CDU) accelerated the end of nuclear power. Those renewable sources of energy weren’t scaling up fast enough to fill the gap,  but gas could be imported from Russia while the wait for renewables went on…and on. Even after Russia invaded Georgia in 2008, German leaders went ahead with Nord Stream 1 which piped natural gas from Russia and even following Putin’s first invasion of Ukraine in 2014, Berlin’s policymakers went ahead with Nord Stream 2 which began construction in 2018.  

In July 2017, Merkel denounced President Trump’s approach to fighting Climate Change at a meeting of the G20 while, at the same time, she was turning Germany into a Russian client state with her own energy policies. In September 2018, Trump hit back, telling the United Nations General Assembly that “Germany will become totally dependent on Russian energy if it does not immediately change course.” In response, the Washington Post reported, “German Foreign Minister Heiko Maas could be seen smirking alongside his colleagues.”  

Russia’s invasion of Ukraine in February 2022 vindicated Trump and wiped the grins off the faces of Maas and his colleagues. Moscow cut off natural gas supplies to Germany and prices skyrocketed for gas and for electricity generated from gas, both key inputs for energy-intensive industries such as steel, fertilizer, chemicals, and glass. Germany had to turn to liquefied natural gas (LNG), super-cooled and imported by ship from Qatar and the United States, all of which cost more than pipeline gas. Electricity now costs industrial users in Germany an average of 20.3 euro cents per kilowatt hour, while its competitors in China and the United States face costs equivalent to just 8.4 euro cents. 

Germany’s political class thought that it could have an industrial economy based on pre-industrial sources of energy like wind and solar. For a time, Russian natural gas allowed them to live that fantasy and lecture those who did not share it. The fantasy is now over, and it turns out that switching your economy to pre-industrial energy sources switches you back to a pre-industrial economy. Germany’s energy-intensive industrial production is now at a level even below those it fell to during the pandemic. 

The country hasn’t seen significant economic growth in five years and 2024 was the second year in a row where Germany’s economy actually shrank. In January, the government cut its 2025 growth forecast from 1.1 percent to 0.3 percent and the number of unemployed hit almost three million, a rate of 6.2 percent.    

Political Realities 

The combination of left and right parties that formed a government after the 2021 elections was doomed to struggle in such circumstances.  

In November 2023, Germany’s Federal Constitutional Court lit the fuse to its eventual explosion when it declared the government’s reallocation of unspent debt proceeds to its climate action budget unconstitutional. To fill the resulting €60 billion shortfall, the government attempted to fill this gap by, among other measures, raising taxes on farmers, prompting widespread protests. In three state elections in September 2024, the coalition parties performed poorly while AfD and the left-populist Sahra Wagenknecht Alliance (BSW) made significant gains. 

On November 1, FDP leader and finance minister Christian Lindner called for tax cuts and a halt in new regulations, and opposed new spending, including on action against climate change. The SPD and Greens branded this “provocation” and on November 6, Chancellor Olaf Scholz (SPD) dismissed Lindner, and the FDP quit the coalition, leaving a minority government.

On December 16, Scholz called (and then lost) a vote of confidence, prompting Sunday’s vote. 

Lessons for America 

In recent years, policymakers across the West, including the United States, have argued for and enacted costly policies to shift from cheap and reliable energy sources to expensive and unreliable ones. Voters have been told that, if everything goes right, not only might this come at no economic cost, but it might even usher in some “Green Revolution.” The fate of Germany’s economy — its entirely self-inflicted crippling in pursuit of a fantasy — exposes the folly of this argument. No government should follow its example and anyone who says it should ought to be dismissed as a crank.   

There is another lesson, perhaps a deeper one. The economic situation, along with mass immigration, has created a situation where AfD can thrive. If they do well, Russia will be blamed and so will populists and populism generally. But it wasn’t populists who crippled Germany’s economy. It was its “moderate” elites, people like Merkel, who did that. If AfD performs well on Sunday, it is to those “moderates” and their disastrous, immoderate policies, that it will owe its success.