The Establishment’s Big Guns Come Out Blazing Against Tariffs
Olivier Blanchard is a renowned economist—former chief economist of the IMF, Robert M. Solow Professor Emeritus at MIT, and Senior Fellow at the Peterson Institute for International Economics. When he speaks, the establishment listens.
So, when Blanchard took to social media Wednesday morning—or “Liberation Day,” as President Trump is calling it—with a long post warning that Trump’s forthcoming tariffs could plunge the U.S. economy into recession, the commentariat responded with glee that their bias against Trump’s economic proposals was being confirmed from on high. His argument boils down to this: tariffs may initially reduce imports and boost domestic demand, but that effect will be offset by rising interest rates, a stronger dollar, falling exports, and ultimately a return to the same trade deficit—just with added costs and a misallocation of resources. In his view, the result is “a general mess”: a recession, no long-term gain, and higher prices paid by U.S. consumers.
Blanchard also says the worst part may not be the tariffs themselves, but the uncertainty they generate. If businesses don’t know whether Trump’s tariffs are transactional, temporary, or permanent, they’ll delay investment decisions. Everyone will “wait,” he says, and that pullback in investment will reduce aggregate demand and trigger a downturn.
It’s a familiar, polished take. But it doesn’t hold up.
The Myth of the Unscalable Economy
Blanchard’s argument starts with the assumption that the U.S. economy can’t scale up production fast enough to meet demand shifted by tariffs. That’s why he believes prices will rise, interest rates will go up, and exports will fall.
But this assumption quietly undermines one of the central claims of free trade itself—that production migrates to wherever it’s most efficient. If U.S. producers can’t respond to increased demand when imports fall, then the “most efficient producers” abroad may actually be earning monopoly-like profits. Tariffs, in this case, wouldn’t distort efficiency—they would reveal inefficiency.
And if we relax this assumption—as we should—Blanchard’s story starts to fall apart. The U.S. economy used to produce a much higher share of its own manufactured and consumer goods. There is no reason, structural or technological, that production can’t scale again—especially if tariffs provide a long-term market incentive.
Inflation and Interest Rates? Not So Fast.
Blanchard’s model assumes that tariffs raise prices and trigger higher interest rates. But again, this view overstates the inflationary risk. Imports make up a relatively small share of U.S. consumer spending—around 11 percent, according to the San Francisco Fed. If tariffs raise those prices, it doesn’t necessarily mean the Consumer Price Index will spike. Prices often fall elsewhere in response. That’s how markets adjust.
More importantly, the Fed doesn’t respond to every price increase. If the inflation is caused by a one-time supply-side adjustment, like tariffs, the Fed may well “look through” any price increases. Boston Fed President Susan Collins already said as much last week, noting that while some tariff-related inflation is “inevitable,” it likely wouldn’t merit a rate hike.
This is fatal to a good part of Blanchard’s case against Trump’s tariffs. If interest rates do not rise, the dollar’s appreciation does not offset the increase in import duties. And without higher interest rates, there’s no drag on the economy.
What About Investment? The Case for Expansionary Uncertainty
Blanchard’s most important argument, however, isn’t about inflation and interest rates. It is that uncertainty surrounding Trump’s tariff strategy—whether it’s permanent or temporary—will paralyze businesses. Investment will grind to a halt, hiring will slump, and the economy will side into a recession.
Economists love the idea that uncertainty is a drag on the economy—especially when they are talking about uncertainty created by a policy they don’t like. In its modern formulation, the idea dates back to a 1975 paper by then graduate student Ben Bernanke. Young Bernanke claimed that when businesses face uncertainty, they respond by pulling back on investment spending and hiring until they receive more information.
But that’s just one response of businesses to uncertainty. And more recent work makes it appear as if the contractionary result is a special and rare response—not what we should generally expect.
A 2016 paper by Raja Patnaik, “Competition and the Real Effects of Uncertainty,” shows that in competitive industries, uncertainty can increase investment. Why? Because in markets where firms compete for market share, the value of waiting is low. Delays just let your competitors move first. Patnaik calls this “expansionary uncertainty.”
Likewise, a 2017 working paper from Norway’s central bank titled “Components of Uncertainty” by Vegard Høghaug Larsen found that some forms of uncertainty—particularly those related to technology and firm growth—lead to higher GDP. Using topic modeling on decades of business news, the study shows that not all uncertainty is contractionary. Some of it reflects opportunity, not risk.
The introduction of new tariffs by the Trump administration bears the hallmark Larsen’s expansionary uncertainty—uncertainty not rooted in financial panic or institutional collapse, but in technological change, shifting industrial policy, and firm-level transformation. In Larsen’s analysis, this kind of uncertainty—captured in topics related to innovation, IT, and corporate restructuring—was associated with rising GDP, not decline. That matches the U.S. economic environment today: firms are facing uncertainty about new tariff regimes, AI integration, domestic supply chain mandates, and shifting global trade relationships—but are responding not by freezing up, but by investing, reorganizing, hiring, and expanding.
Similarly, under Patnaik’s framework, today’s tariff-driven uncertainty is a textbook case of expansionary uncertainty in a competitive economy. When tariffs are introduced or threatened, firms in competitive industries—such as manufacturing, logistics, and retail—face pressure to restructure supply chains, invest in domestic production, and secure alternative inputs before their rivals do.
Patnaik’s research shows that in such sectors, uncertainty doesn’t lead to paralysis—it sparks a race to adapt. That’s exactly what we’re seeing now: companies aren’t waiting for perfect clarity on trade policy—they’re investing preemptively to gain advantage in a newly configured global marketplace. The uncertainty created by tariffs, far from stalling growth, is driving a wave of capital spending and strategic repositioning.
That’s the context Blanchard misses. Tariffs don’t just raise costs or shake confidence. They can reshape incentives, prompting firms to invest at home, rebuild supply chains, and take advantage of newly sheltered markets.
Liberation from Old Anti-Tariff Cannards
Blanchard’s warning is rooted in models that simply do not reflect the current reality of the U.S. economy. They might work for the kind of small, open economies that populate economic working papers. They don’t work for an economy with the size, vibrancy, and openness of the United States.
The old trade regime produced massive trade and budget deficits, supply chain vulnerabilities, and a hollowing out of American industry. Trump’s “Liberation Day” tariffs are a response to that failure—not a cause of new dysfunction.
Will there be uncertainty? Yes. But uncertainty isn’t always economically harmful. In fact, the tariffs of Liberation Day may be exactly what we need to break out of the low-investment, high-dependence trap that the free trade consensus left behind.
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