David Henderson has an excellent post on the effect of tariffs on the price level. I agree with his analysis, but here I’ll reframe the debate in a way that I hope will also be helpful. Let’s begin with a few propositions:
1. Under the vast majority of policy regimes, the imposition of tariffs leads to a higher price level. These include the Fed’s current (asymmetrical) flexible average inflation targeting (FAIT) regime, but also the gold standard, money supply targeting, and nominal GDP targeting.
2. There are a few policy regimes where tariffs are not inflationary, including price level targeting and symmetrical FAIT. I know of no country that uses either regime.
3. Tariffs reduce real output. Thus if the monetary authority prevents any rise in the price level, then NGDP would decline. This would cause a rise of unemployment above and beyond any unemployment directly caused by the tariffs.
If a politician tells you that his tariff proposal will not cause inflation, and if you believe him (Yes, I know. . . ), then you should be very worried. That would mean that the tariff plan was to be combined with a monetary regime that made the welfare losses even larger than otherwise.
Do tariffs cause inflation? Let’s hope so!
PS. The best argument against tariffs is not that they cause inflation, rather it is that tariffs cause lower real output.
READER COMMENTS
Tristan
May 14 2024 at 5:57pm
Couldn’t tariffs be deflationary under the gold standard and even money supply targeting? If tariffs lower investment and cause rates to fall, gold demand would increase as the opportunity cost of holding gold declines. I recall you’ve argued this was the case with Smoot-Hawley, no?
Scott Sumner
May 14 2024 at 7:32pm
Yes, good point. I’d still argue that in the long run they are inflationary, but in the short run they could lower gold velocity, as you suggest.
David s
May 15 2024 at 1:47am
Since Biden and Trump are unfortunately aligned on this issue we can expect an escalation of tariffs over the next four to six years no matter who is in office. I’m most curious about the impact on American auto manufacturing and the choices we have as consumers. The following scenario seems likely:
-Chinese cars are effectively banned in the U.S. for several years
-American manufacturers, and those European & Asian companies that have plants already on U.S. soil, continue making a significant volume of large, gas powered vehicles and don’t innovate because of the protection they’re receiving from the tariffs
-Eventually, Chinese brands find a way to enter the U.S. and fight for sales in niche areas of the market with superior products and better pricing than the incumbent car makers
-Domestic companies start losing market share more broadly because their products are inferior to the Chinese imports
Whoops, I just wrote a synopsis of The Reckoning by David Halberstam.
Scott Sumner
May 15 2024 at 1:31pm
Populists on both the left and the right continually whine about stagnant living standards. Just imagine the boost to living standards if working class people could buy a high quality electric car for $10,000!
Andrew_FL
May 15 2024 at 3:33pm
Imagine the boost to living standards if working class people could buy a gasoline powered car for $10,000.
MarkW
May 15 2024 at 6:03am
I fear advocates of tariffs would consider possible inflationary effects as an acceptable cost of producing the supposed benefit of ‘keeping the money in the country’ and ‘protecting jobs for American workers’ or some such.
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