The Fed will ultimately offset the trade shock, though reluctantly

Originally published August 7

It is hard to estimate the likely hit to US growth from the trade war.   The path of policy itself is unknown and the knock-ons to business hesitation, as opposed to mechanical tax drag, are elusive.
 
However, we may expect that the Fed will attempt systematically to offset these drags by easing policy.  The central bank is not prescient, so they will misjudge the size of the shock and therefore over-react or under-react to some extent.  This creates a wider range of potential outcomes and probably explains why people refer to the trade issue as raising the recession risk.  However, we cannot put a sign on the direction of the Fed’s misjudgment.  And the mean of the distribution is simply that the shock will be offset.