November 20, 2024: Are Tariffs Really Inflationary?

Since the election, many have assumed higher tariffs will lead to higher inflation. However, a closer look reveals this may not be the case. During the 2018 trade war, PCE inflation actually trended slightly downward despite increasing tariffs, as represented by tariff revenue.

Why might tariffs be less inflationary than expected? A tariff is a tax on imported goods. When taxes increase, some cost is borne by businesses via lower margins, and some cost is passed through to consumers via higher prices. It is too early to say which will bear more of the tax burden this time around, but considering the high prices already faced by consumers, businesses may have to accept lower margins rather than increase prices.

Even if the cost is borne by consumers, a tax is a one-time price increase. Inflation is the rate of price increases over time. Thus, a tariff does not directly increase inflation after it is in place.
Finally, imports are about 14% of GDP.* While not insignificant, this potential price increase affects only a fraction of the economy. Put it all together, and tariffs may not be so inflationary after all.

Weekly Market Update: November 20, 2024