By Dr. George Calhoun
Executive Director of the Hanlon Financial Systems Research Center at Stevens Institute of Technology
Will Higher Tariffs Cause Inflation?
Many people say yes. But some disagree. There is evidence for both views, but much is unclear, and that uncertainty has confounded the Federal Reserve, unsettled the financial markets, and alarmed the general public.
There is a lot to sort out, and the discussion is lengthy — so we’ll begin with an executive summary.
Executive Summary
The case for tariff-induced inflation is straightforward: adding a tariff tax, like any tax, should raise end-user prices on affected products.
But the evidence is weak, for two reasons.
First, the U.S. has been in a low-tariff mode for almost 90 years, and there is little recent experience to draw on in order to forecast the effect of broad-based high-tariff policies on a 21st century globalized, tech-heavy, service-based economy.
Second, although some evidence is available for the 2018-2019 tariffs — which were part of a mini-trade-war with China — the calculations show surprisingly small inflation effects. And there is no correlation between customs duties (perhaps the most solid data on tariff impact) and the inflation rate.
There is also a methodological weakness. Models designed to predict the effect of tariffs on prices mostly ignore the possibility of behavioral adjustments by consumers, producers, retailers, and regulators which tend to “dampen” the potential inflationary effect.
The case against an inflationary outcome is based on the idea that price increases due to tariffs on imported products may be offset by changes in the exchange rate between the exporting country’s currency and the dollar. Devaluation of export countries’ currencies does appear to have taken place when U.S. tariffs were raised in 2018 (as “trade theory” predicts), which may account for the weak inflationary impact noted above. And correlations of exchange rate adjustments (devaluations) with increasing tariff revenues are moderately positive.