Trump’s dangerous economic experiment

Start with budget policy. There can be no doubt that Trump inherited from Joe Biden unsustainable public finances due to the former president’s public spending largesse. According to the nonpartisan Congressional Budget Office, as Trump started his second term, the budget deficit was set to remain at 6% of GDP as far as the eye could see. By 2034, such deficits were expected to increase the public debt in relation to the size of the economy to its level at the end of World War II.

Rather than do the responsible thing and take measures to put our public finances on a sustainable path, Trump is pursuing policies that will get the country into a deeper budget hole. According to the CBO and the Joint Committee on Taxation, over the next decade, Trump’s One Big Beautiful Bill Act of unfunded tax cuts will add around $3.4 trillion to the budget deficit. Meanwhile, in the wake of the Iran war, Trump is proposing a $500 billion increase in defense spending over the next two years without indicating how that spending is to be funded.

The net upshot is that our government will have to finance budget deficits in excess of $2 trillion a year for the foreseeable future. It will also have to roll over $9 trillion a year in maturing debt. That could prove difficult if foreign investors, who own around a third of all outstanding Treasury bonds, come to fear that we will try to inflate our way out of our debt problem. The Trump administration would do well to heed the warning signs that are now coming out of the bond market. Since the start of the year, the 10-year Treasury bond yield has risen by around 40 basis points to 4.3%, at a time when we would have expected Treasury bonds to benefit from safe-haven demand in response to the Iran war.

If ever there were a time to adhere to the earlier Republican Party’s sound monetary policy orthodoxy, it has to be now. Not only do we have a gaping budget deficit, but we also have inflation being boosted by high energy costs in the wake of the Iran war and by Trump’s import tariff policy. Yet, since the start of his second term, Trump has been browbeating the Federal Reserve to cut interest rates and has been on a campaign to mold the Fed in his image. He has nominated a monetary policy dove to replace Fed Chairman Jerome Powell. His Justice Department has also brought criminal charges against Powell in an effort to remove him from the Fed’s board when his term as Fed chairman expires this month.

From time immemorial, the Republican Party was the party of free trade. That seems to have come to an abrupt end in April 2025 when, on “Liberation Day,” Trump hiked import tariffs to their highest level in the past 100 years. Even after the Supreme Court struck down Trump’s tariff hikes on national security grounds, we now have a general import tariff of 15% on virtually all of our trade partners, and a 50% tariff on all steel and aluminum imports. In addition to boosting inflation by around 1 percentage point, those tariffs are likely to seriously limit the long-run benefits that we might derive from international trade.

Perhaps Trump’s most surprising departure from Republican Party orthodoxy has been in industrial policy. Until Trump came to office, industrial policy was long a term of abuse in Republican circles as a shorthand for the misguided belief that government bureaucrats could allocate capital more efficiently than markets. Yet, Trump has embraced such a policy, particularly around manufacturing, steel, semiconductors, and energy. In a manner more to be expected from a socialist government than a Republican administration, Trump has had the government acquire a “golden share” in U.S. Steel and a 10% stake in Intel. He has also proposed a 10% cap on credit card interest charges and imposed a 15% government cut on Nvidia’s Chinese chip revenues. 

Trump’s sharp departure from earlier Republican Party orthodoxy is particularly regrettable, coming at a time when the artificial intelligence revolution is gathering steam. That revolution offers us a once-in-a-generation opportunity for rapid economic growth and low inflation. Instead, Trump’s highly unorthodox policies heighten the chances of a resurgence of inflation and financial market instability as the government struggles to finance ever-increasing budget deficits.

American Enterprise Institute senior fellow Desmond Lachman was a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging-market economic strategist at Salomon Smith Barney.