Tariffs, Inflation, and an AI Bubble: Highlights from Economic Outlook 2025

How could a new Fed chair affect the agency’s relationship with the White House?

Kroszner stated that there had been a lot of “clutching of pearls” over the criticism the administration had levied against current Fed Chair Jerome Powell, noting that there was no shortage of tough criticisms directed toward the agency during the Great Recession, when Kroszner served as governor of the Federal Reserve System.

Kroszner pointed out that markets have remained stable despite many raising concerns about the friction between the White House and the Fed.

“I think also there's a lot of faith that the markets have in (US Secretary of the Treasury) Scott Bessent to step in if something is getting out of control,” Kroszner said. “I think that, along with the checks that the Supreme Court have so far exercised and the checks provided by the Senate confirmation process for Fed governors and the chair, help to explain why the markets have been relatively calm.”

Kroszner concluded his response by arguing that dissent is not always a bad thing and can be useful in providing transparency into the decision-making process, particularly during uncertain times.

How have tariffs impacted the economy—especially the manufacturing sector?

Professor Rajan said that tariffs exerted a small amount of influence in bringing manufacturing back to the United States, noting that certain US car manufacturers had moved plants from Canada to the United States.

“The question, however, is: Is it going to make the United States a manufacturing power?” Rajan said. “And the answer is, probably not.”

Reiterating a point he made at last year’s Economic Outlook, Rajan said that manufacturing jobs for semi-skilled workers with high school degrees don’t exist anymore because many of those tasks are now performed by machines.

Rajan went on to question the benefits of bringing manufacturing back to the United States. “There’s not so much advantage in bringing manufacturing of a lot of stuff back home,” he said. “It’s going to cost us a lot more for our customers to pay for that stuff. Just leave it overseas.”

Rajan predicted that tariffs would raise prices for consumers in the long run because of extra costs for manufacturers and a lack of competition.

Professor Ma, agreeing with Professor Rajan, stated that since 2020, investment in US manufacturing had nearly doubled, but that the employment difference between now and 2019 was “almost zero,” despite the dramatic increase in investment.

“I think, ultimately, there are economic laws that are difficult to defy,” Ma said. “Consumers buy cheap things, you cannot peg long-term interest rates, you cannot peg long-term output, and you cannot direct trade, as in command and control. This administration sometimes seems extremely empiricist,” she said, suggesting the current administration is very willing to try policies that can run counter to established economic principles.

Professor Kroszner, agreeing with Professor Rajan that long-term negative effects of tariffs were possible, echoed a point he made during Economic Outlook 2024 that tariffs are harder on other countries than on the United States because trade is a much smaller fraction of GDP for the United States than for other countries. Therefore, he contended, tariffs could be used as an effective negotiating tool. Kroszner also pointed out that some of the United States’ biggest exports, such as energy, are not goods that other countries would voluntarily place reciprocal tariffs on. So except for some farm products, there is relatively limited scope for retaliation by other countries—which is what we have observed, he noted.

What effect will AI have on the real economy? Are we experiencing an AI bubble?

“The impact on the real economy, I think, depends a lot on the ultimate adoption and use of AI,” Professor Ma said. She explained that the downstream implementation of AI products by American companies are harder to predict, and that the implementation is crucial for understanding whether AI investment will turn into economic growth and productivity gains.

Professor Rajan agreed with Professor Ma, stating that we have not yet seen the “final adoption point” of AI and how it will benefit companies and consumers.

“Where do AI companies think they’re going to make the money if they’re competing with each other, and they don’t have final demand yet?” Rajan said. “Until you have that final demand, all this could just be investment, and you need to translate [it into profit].”

As with all new technology, Rajan argued, it will take time for AI products to be implemented and adopted. He used the example of the automatic telephone, which was first invented in 1920, but did not fully replace all human telephone operators until 1985—65 years later.

Professor Kroszner pointed out differences between the dot-com boom of the late 1990s and early 2000s and the current AI investment boom, voicing concern that some investors in AI were beginning to take on much more debt than dot-com investors in the late 90s.

“That’s the thing that worries me,” Kroszner said, “that when some of these firms get into trouble, it can have bigger economy-wide impacts. That then affects the banking sector and the availability of credit. Liquidity can dry up, so the situation could become closer to what happened with the mortgage crisis.”

Will China stabilize growth in the face of the its multiple economic crises?

“The property market cycle probably will take some time to play out,” Professor Ma said. She predicted that China would continue investing heavily in AI and robotics, as well as other sectors where its economy had a clear advantage, but also noted its major economic issues: low consumption, deflation, and low consumer sentiment.

Professor Rajan asserted that the real estate downturn in China was a “huge issue” that had spilled over into other parts of the economy.

“Land sales used to be a big part of revenues for the local governments. But with prices having fallen so low, land sales are no longer possible, so the pressure has fallen on production to be the source of revenues for companies,” Rajan explained. He went on to say that China had a problem with overproduction because manufacturers were being pushed to produce by local governments.

“The right way to deal with this is to stop the overproduction,” Rajan continued. “But for that, you’ve got to go into the incentives of the local governments.”

“One of the major challenges is the dramatic decline in working-age population because of the one-child policy,” Kroszner added. “Demographics are having a significant impact by reducing growth due to fewer workers and adding downward pressure to the property market by reducing housing demand. On top of this is lower overall domestic consumption, both because of a rapidly declining population and because of a very high savings rate. The pieces just don’t fit together.”

What concerns do you have for the economy in 2026?

Professor Rajan voiced concern that the Fed may be cutting rates too early and referred to the U-shaped interest rate curve that commonly occurs before financial crises.

“I don't think we’re at a tipping point yet, but I think we could be building toward that tipping point if the Fed is not careful. That’s my worry,” Rajan said.

Professor Ma brought up the poor financial situation of higher education institutions, compounded by federal cuts to research funding. The lack of support could have global implications when it comes to innovation and competition, Ma argued. She noted that China is investing heavily in science, and that many top scientists now are choosing to work in China instead of the United States.

Professor Kroszner raised the issue of sudden revaluations of asset prices, especially in areas of heavy investment like AI. Since a lot of investment is happening through private equity, Kroszner explained, revaluations could be more dramatic.

“What if someone has to sell one of these large investments at a 40 percent discount to the private equity valuation? Everything else then comes down with a 40 percent discount, and even if people can’t get out of their private equity investments with their lower valuations, they’re going to have to sell somewhere in the system,” Kroszner said.

On December 10, 2025, Professor Ma and Professor Rajan joined Brent Neiman, the Edward Eagle Brown Professor of Economics, at the New York Economic Outlook event, in a conversation moderated by Ray Iwanowski, MBA ’97.

Interested in hearing more about what lies ahead for the economy in 2026? Register for Global Economic Outlook, a virtual event taking place on January 28, featuring Veronica Guerrieri, the Ronald E. Tarrson Distinguished Service Professor of Economics and Willard Graham Faculty Scholar; Chang-Tai Hsieh, the Phyllis and Irwin Winkelried Distinguished Service Professor of Economics and PCL Faculty Scholar; Luigi Zingales, the Robert C. McCormack Distinguished Service Professor of Entrepreneurship and Finance; and moderator Romesh Vaitilingam, writer, consultant, and editor-in-chief of Economics Observatory.