Will the Trump Tariffs Be Inflationary?

Tariffs appear to be inflationary on the face of it. A rough estimate is that CPI would rise from 2.8% to 4.7% over the coming year. But tariffs were not inflationary at all in the 2018-2019 episode. That might be because the currency of China – the focus of most of those tariffs – weakened significantly. This time, without such a safety valve, it is not clear from first principles that the tariffs will be inflationary overall, even if they raise the prices of certain individual goods and services. Where a good has a domestic substitute, it’s not clear in a competitive equilibrium that domestic producers have scope to raise their prices to the tariffed level. Where there is no domestic substitute, as with, say, cell phones, the substitute is to buy fewer cell phones. But to the extent that certain prices rise, budget-constrained consumers have to buy less of other items, and their prices will fall. That is recessionary, not inflationary. Credit utilization or stimulus payments could offset that, but then it would be money-growth, not tariffs that would have caused any inflation. CPI does not capture substitution or go-without effects, so any tariff-driven inflation at all will show up most intensely in that flawed index. Thankfully, PCE, the Fed’s preferred index, fully accounts for such effects.