Tariffs and Their Impact on the Economy
The relationship between tariffs and inflation has been a topic of discussion among economists and policymakers. A recent study that examined 150 years of tariffs in the U.S. and abroad found that tariffs disrupt the economy and financial markets, leading to lower inflation. This conclusion challenges the conventional wisdom that import taxes lead to higher prices.
Understanding the Study’s Findings
The study, conducted by San Francisco Fed researchers Régis Barnichon and Aayush Singh, analyzed the effects of tariffs on the economy and found that higher tariffs lead to reduced economic activity, higher unemployment, and lower inflation in the short term. This is contrary to the predictions of standard economic models, which suggest that tariffs should lead to higher inflation.
Possible Explanations
The study suggests two possible explanations for the unexpected relationship between tariffs and inflation. Firstly, tariffs create uncertainty that hits consumers’ and investors’ confidence, depressing economic activity and putting downward pressure on inflation. Secondly, tariffs could trigger a drop in asset prices, which also weighs on demand, resulting in higher unemployment and lower inflation.
Historical Context
The study found that before World War II, a permanent 4-percentage-point increase in the tariff rate reduced inflation by 2 percentage points and raised unemployment by about 1 percentage point. After the war, the estimates are more uncertain but still point to tariff hikes reducing inflation and worsening unemployment.
Trump Tariffs
The Trump administration has maintained that tariffs are not stoking inflation, despite the consumer price index creeping higher since the launch of the trade war. However, the recent decision to scrap tariffs on certain commodities suggests that the administration is responding to growing concerns about affordability.
Economic Resilience
Despite fears of a recession, the economy has remained resilient, with GDP rebounding strongly and consumer spending continuing to expand. However, employment has slowed sharply, with payrolls growing by just 22,000 in September. The low-hire, low-fire labor market is also a factor in this slowdown.
Conclusion
The study’s findings suggest that tariffs may eventually lead to lower inflation, but this may not be enough to alleviate concerns about affordability. Voters are demanding improvements in overall affordability, not just slower price growth. As UBS Global Wealth Management’s Paul Donovan notes, "People are angry about the loss of affordability, and are inclined to blame incumbent governments for this." The relationship between tariffs, inflation, and affordability is complex, and policymakers must carefully consider these factors when making decisions about trade policy.
