More Fully Understanding Tariffs

Tariffs are difficult for those paying them. Take American importers for instance; they are trying to remain competitive (which is often a function of price) while also remaining profitable.  When Liberation Day hit the global economy last year, there was speculation across the spectrum of potential outcomes.  Some worried the economy would crash, while those in support of them insisted they would help make matters better.  So, what is the answer? Great question! It’s still probably too early to know how the impact beyond specific firm levels will unfold, but the San Francisco Federal Reserve Branch did post this research note to offer some historical context.

The group looked at big tariff changes from the late 1800s through the 1930s for answers.  Authors from the bank found that tariffs have a tendency to raise unemployment, something that could be underway in America now.  We’ll get some revised numbers soon from the Bureau of Labor Statistics on the unemployment situation here at home which might put more emphasis on this finding. The study also suggests that economic activity tends to weaken and that inflation falls. While nobody wants a slower economy, less inflation would likely please many, even if prices do not actually fall.  In short, their regression model shows that for every 1 percentage point increase in tariff, inflation declines 0.6 percentage point, and that higher tariffs are followed by higher unemployment for up to two years.

Tariffs leading to falling inflation seems counterintuitive, so the authors offer an explanation.  They suggest that rising uncertainty associated with the tariffs worries consumers and businesses enough to cause them to cut spending.  The falling demand allows prices to adjust downward. Importers, unable to adjust their supply chain, can be in a real difficult place here as their costs rise but demand declines.  The authors also point out that America relies much more on imports than in prior tariff-hiking regimes, so that could push against a past tendency to see price pressures moderate.

In the end, the full impact of these tariffs will take time to reveal itself, especially as firms, consumers, and policymakers around the world continue adjusting.  This lookback offers guidance which is likely limited given the interconnectedness of today’s global economy. What does seem to echo, however, is the uncertainty. As new data emerges, a clearer understanding of how the multitude of dynamics unfold and whether post-Liberation Day trade policies support or hinder long-term economic goals.