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.
That said — the scope of the recent tariff proposals is very large compared to past trends. The surge in prices could be much greater than currency offsets could compensate for. This may cause “nonlinear” responses, which could produce entirely new patterns of behavior. In fact, the initial response to the latest tariff proposals in the currency markets was the opposite of what “theory” calls for – instead of appreciating, the dollar index has fallen by about 2.5% since the “Liberation Day” announcement.
The prior column reviewed the Certainties related to tariffs — the Known Knowns that all sides can agree on.
The inflation question is one of the most important Known Unknowns associated with tariff policies. That is the subject of this Part 2.
The details follow.
The First Answer: Prices Will Rise
Are tariffs inherently inflationary? For many economists and policy-makers (and for the headline writers), the answer is obvious.
“Tariffs are ‘simply inflationary,’ economist says” – CNBC headline (March 20, 2025).
“Trump’s tariffs are ‘likely’ to push prices up, Fed chief warns” – Washington Post headline (April 17, 2025)
“Tariffs are simply taxes that are passed on to the consumer.” – Fox News
Tariffs “are poised to raise inflation in the United States.” – The New York Times (April 14, 2025)
“Tariffs Threaten to Stoke Price Pressures” – The Wall Street Journal headline (April 10, 225)
“Tariffs Are Likely to Increase Inflation” – Financial Times headline (April 16, 2025)
Indeed, it seems self-evident. If a 10% tariff is imposed on imported products…
“…the price level has to go up when you put a levy on goods that people are buying…” – Larry Summers
The argument is logical, even tautological. Yes, the real world is messy. But aside from delays or “frictions” or various adjustments (reviewed below) which might cushion the impact of a tariff tax, it seems clear that the direction of the pressure on prices must be upward — i.e., inflationary. (Per Summers, this is “something that almost all economists agree on.”) The only dispute might be over how much of an increase consumers would see in the end.
Let us call this Construct Number 1.
There is, however, another way of looking at the question — which can seem just as logical — and which leads to a different answer.
The Alternative View: Currency Shifts Neutralize Price Increases
Some economists assert that tariffs do not cause inflation. The reasoning can be complex and hard to follow, and sometimes ideological. But one counterargument stands out clear and clean.
“In theory, tariffs should be partially offset by a currency appreciation in the tariff-imposing country or by a depreciation in the country on which the tariff is imposed.”
This is Construct Number 2.
Again, it seems logical. If a tariff imposed by the U.S. raises the price of products imported from Country X by 10%, but the currency of Country X devalues by 10% relative to the dollar, the end-price to U.S. consumers would be unchanged.
If this is so, it also implies that tariffs are ineffectual. As liberal economist Joseph Stiglitz commented with respect to a U.S./China tariff war: “A higher [American] tariff will result in a depreciation in China’s exchange rate, partially undoing any hoped-for benefits.”
Thus even some opponents of tariffs accept Construct 2, and cite it as a reason to reject them.
“A common argument against tariffs is that their effect is likely to be mitigated by endogenous offsetting movements in exchange rates.”
Of course the word “partially” muddies the picture somewhat, but again the direction of the pressure on prices is clear – in this case, it is downward.
Comparing The Two Constructs
Both arguments seem internally coherent. Which better describes how tariffs actually work?
There are three places to look for answers:
- Informed opinion — we might say interested opinion — the views of investors, business leaders and policy makers backing up significant business decisions, investments and policy initiatives where real money is on the table.
- Evidence from with the first round of tariff hikes in 2018 and 2019, mostly focused on China.
- Economic models of proposed 2025 tariff scenarios.
Evidence For Construct 1: Tariffs Cause Inflation.
1. Informed Opinion
The leadership of the Federal Reserve has weighed in cautiously in favor of Construct 1. Chairman Powell sees inflation “likely” in the forecast.
So, too, Wall Street.
Prediction markets project an 80% chance that inflation will exceed 3% this year, and a 60% chance that it will not exceed 4% – roughly in line with Wall Street experts.
Then there is the financial market itself, a vast information processing engine, sorting and compiling millions of investors’ interested viewpoints. The markets generally react somewhat negatively to tariff announcements, but the violence of the reaction to “Liberation Day” was extraordinary.
A decisive expression of unhappiness, certainly – though how much of this is based on inflation fears (as opposed to concerns about a recession or other factors) – is hard to say.
2. Evidence From The 2018-2019 Tariffs
Tariffs on China in 2018 and 2019 (retained thereafter) were the first significant upward revision in rates in several decades. They applied to a substantial trade flow and resulted in a tripling of tariff revenues compared with the average of the previous several decades.
One academic study of the episode found that by December 2018, import tariffs were costing U.S. consumers an additional $3.2 billion per month. Another study by the National Bureau of Economic Research found that on an annual basis —
“…prices of imports targeted by tariffs did not fall, implying
complete pass-through of tariffs to duty-inclusive prices. The resulting losses to U.S. consumers and firms who buy imports was $51 billion, 0.27% of GDP. After accounting for tariff revenue and gains to domestic producers, the aggregate real income loss was $7.2 billion, or 0.04% of GDP.”
The Boston Federal Reserve performed a more granular analysis and concluded that the 2018 tariffs raised the core Personal Consumption Expenditures Index — the Federal Reserve’s preferred measure of inflation — by 0.1% to 0.2%.
3. Modeling ‘Liberation Day’
Economists have scrambled to model today’s frequently changing tariff scenarios and forecast the impact on consumers.
Yale University’s Budget Lab estimates the cost in lost purchasing power of the Liberation Day tariffs at $3800 per household. This appears to be the source for Janet Yellen’s claim that “estimates suggest” an “impact in the region of $4000 per household.”,
Larry Summers takes it much further. In an interview with Fortune Magazine, he launched this screamer:
“The best estimate of the loss from tariff policy is now closer to $30 trillion or $300,000 per family of four.”
[Note: The tariff-induced “loss” that Summers projects is larger than the entire U.S. GDP.]
Even the lower numbers cited by Yale and Yellen are questionable. A rough estimate based on the 2018 data gives a figure of about $30/month increase in the cost of living per household ($50 Bn in consumer “impact” spread over 132 million households). The Tax Foundation arrives at a similar estimate of the impact for tariff revenues per household.
Of course, these numbers would go up with the higher tariffs proposed. The Tax Foundation calculates that the average effective tariff rate could rise four and a half times, from 2.5% to 11.5% (allowing for some “behavioral adjustments” – described in the next section) — which could push tariff tax per household above $1000/yr.
In terms of inflation rates, the Boston Fed study estimated that the 2025 proposals could add from 0.5% to as much as 2.2% to the Core PCE, depending on various scenarios — and “keeping all else in the economy constant.”
The Yale Budget Lab model yielded a similar conclusion: “the price level from all 2025 tariffs rises by 2.3% in the short-run.”
Mitigating Factors: Caveats, Fudges And Assumptions
“The short run” — “all else constant” … These economic models accept characteristic limitations, which call for critical attention in interpreting the results.
1. Is Inflation Being Measured Properly?
There are more than a dozen “official” inflation metrics used by the Federal Reserve in various contexts. The range of figures they produce varies often by a factor of 2 to 1. Here is how things stood in December 2021, for example.
Which “inflation” should we target?
This is a general problem, which most economists ignore. But when a model forecasts a change in the inflation rate of 0.1%, 0.8% or even 2%, it may be less than the variance across this range of alternative metrics. This should call for caution in interpreting the significance of the results.
2. Is It Really Inflation At All?
It is an under-emphasized truism: High prices are not the same as inflation.
Talk of “high prices” refers to the current price level — regardless of how fast or slow prices became high. “Inflation” refers to the rate of change in prices. Prices can stay high even if inflation slows down or stops, because inflation measures the change in prices, not their level.
This is relevant here because most observers accept that a tariff increase creates only a one-time elevation in prices — a “bump” — not an ongoing speed-up in future price increases. The surge is described as “temporary” even by those who are generally hostile to tariff increases (NY Times, 4/14/25). Fed Chair Jerome Powell has revived the controversial word “transitory” in this context.
“Transitory” seems to apply in the case of the 2018 tariffs. Another study showed that the cost impact on “final goods” lasted only 4 quarters – and in fact, the tariff shock was found to have produced “a one-time rise in the price-level occurring” in the quarter following the imposition of the tariff. The effect appears in quarters 2 through 4 only because of the way that inflation is measured on a year-over-year basis. After 4 quarters, the effect is slightly deflationary.
Viewed in this light, a one-time tariff-induced rise in prices would not qualify as “inflation.”
3. Tariffs Affect Only A Small Portion Of The Consumer’s ‘Market Basket’
It is estimated that imports account for about 8% of the Fed’s preferred inflation metric — the Personal Consumption Expenditure Index — and just 10% of the Core PCE (excluding food and energy). The effect of an X% tariff tax on imports translates to about one tenth of X% impact on the PCE.
The model results seem to validate this. The average 22% to 24% tariff rate cited by some (at the high end) for “Liberation Day” scenarios would correlate with the one-time PCE increase of 2.2% cited in the Boston study, or the 2.3% increase projected by the Yale study.
[The indirect costs of tariffs, when they apply to goods used as inputs to finished consumer products, may increase this effect.]
4. Inflation Is Multicausal, Multidimensional And Over-Determined
Inflation is a notoriously complex phenomenon, conceptually and empirically. Like a fever, it is a symptom that can have many causes. The (small? transitory?) impact of tariff increases may be overwhelmed by more general disinflationary trends, driven by declines in energy prices (down almost 20% since January), rent (down 20% since last summer) and consumer credit costs (rates on credit card balances, auto loans, mortgages are all down significantly in the past three quarters). Tax relief would contribute to the downward trend in the cost of living (even though most taxes are not included in the PCE). And if the Fed does reduce interest rates later this year it would further ease inflation. Most models assume that all other sources of price pressure are absent or held constant, but this is not realistic. It may be hard to detect the presumed inflationary up-signal of tariffs amidst a flood of down-signals from other sources.
5. The ‘Partial Equilibrium’ Dodge
Economists like to distinguish between so-called “partial equilibrium models” and “general equilibrium models.” In the case of tariff studies, partial equilibrium models assume that except for the tariff increase “nothing else changes.” General equilibrium models take into account the responses and adjustments by other actors in the system, like consumers and competing producers.
All of the studies cited here rely on partial equilibrium models. The Boston study acknowledges this.
“It is important to emphasize that our estimates represent a first-round effect on prices. That is, they do not take into account how consumers and competitors eventually might adjust to the import price.”
The following table summarizes some of the modeling simplifications that are relevant for forecasting tariff impacts.
Retailers do actually absorb part of the tariff tax. Consumers do substitute. When French champagne is dear (as the British would say), we drink Californian. Demand is elastic. When eggs are expensive, people buy fewer eggs.
Partial equilibrium models assume no adjustment to higher prices by consumers, competing producers, retailers or regulators – and this is a significant loss of realism, which most studies admit.
“We assume that demand will remain constant despite the price changes and that consumers will not substitute to different products or similar products from different countries.”
“This is a total effect without dynamics; our current analysis does not allow for an estimate of the time period over which we might see this outcome.”
“Our estimates give the first-round impact of tariffs on inflation, holding quantities constant (that is, we calculate the effects under partial equilibrium). In other words, we assume that demand will remain constant despite the price changes and that consumers will not substitute to different products or similar products from different countries. We also assume that wages, non-tariff taxes and subsidies, and productivity will stay constant.”
“Overall, we would expect general equilibrium effects…to dampen our inflation estimates…”
Collectively, these factors may collectively provide a large cushion against inflation. The Tax Foundation study estimates that “behavioral factors” would reduce the impact of the Liberation Day tariffs — measured as the “average effective tariff rate” — by almost 40%.
But the biggest factor missing from the models is the one that Construct 2 is based on: shifts in exchange rates.
Evidence For Construct 2: Currency Adjustments Offset Tariffs
There is considerable evidence that tariff-induced currency adjustment does (sometimes) take place.
The 2018-2019 Tariff Episode
In 2018-2019 the U.S. imposed new tariffs of 15.1% on average on imports from China. Average tariff rates overall reached about 3%.
The Dollar appreciated, as theory predicts. The DXY index (which compares the dollar to a basket of hard currencies) gained “up to 10% during tariff announcement windows in 2018 and 4% in 2019.”
When the tariffs were announced in April 2018, both the Yuan and the Euro fell more than 10% from their Q1 peaks.
The effect was broad-based. Almost all other currencies devalued relative to the dollar. (Some of this effect may be due to the Federal Reserve raising interest rates, but the Fed increases were modest – only about 50 basis points – over this time period.)
A recent academic study of the 2018 episode detailed the inverse relationship between U.S. tariff measures and the Renminbi-Dollar exchange rate.
Each tariff “pulse” tended to push the currencies further apart – the Dollar up and the Yuan down – though the effect was often felt only a few months later. The authors concluded that these currency movements were indeed due in large part to tariff offsets – especially for the Chinese side of the equation.
“Tariff news explained at most one fifth of the dollar effective appreciation but around two thirds of the renminbi effective depreciation observed in 2018-19.”
2025 Currency Movements
It is still early to expect to see major exchange rate shifts in response to the Liberation Day tariffs. Nevertheless, the Yuan has weakened a bit, falling to its lowest level since 2007.
“Beijing made one striking move this week when it let the renminbi weaken against the dollar.” – Financial Times (April 9, 2025)
“China has fixed the renminbi at its weakest level in 18 months in the first sign it will permit currency depreciation to offset an escalating trade war with the US.” Financial Times (April 8, 2025)
“The move, which saw the spot renminbi weaken both onshore and offshore, came despite an overall decline in the dollar against major currencies.” – Financial Times (April 8, 2025)
The value of the Yuan is closely managed by the Chinese government, but not without constraints. There is reason to believe that the offset mechanism may not be as potent in 2025 as it was in the prior episode. In early 2018, the renminbi was quite strong relative to the historical trend, and there was latitude to allow for depreciation to offset the tariff hikes. In 2025, the situation is different. The Chinese economy has struggled of late, and the Yuan is already much weaker. Beijing may have less room to maneuver rates downwards without risking other financial consequences (capital flight, financial instability).
Summary On Tariffs And Inflation: The Big Picture
“It is going to be very difficult to have a precise assessment of how much of inflation is coming from tariffs.” – Jerome Powell
First of all, with respect to the models, what is striking about these studies is the rather modest impact they project. A bump of 0.1% in the PCE is practically de minimus. Even an increase of 1-2% in the inflation rate is arguably more of a perturbation than a game-changing crisis, and if the increase is spread out over time by retailers temporarily absorbing some of the cost, the impact would be muted – even before considering the other “behavioral factors.” The net figures for estimated “consumer impact” in many of these studies would be tiny rounding errors for a $30 Trillion economy.
As for the hard data — actual tariff revenues were about $80 Bn last year (2024). True, that was three times higher than the pre-2017 average — but it is still less than 3/10ths of 1% of the U.S. Gross Domestic Product. Double or triple it… and it still may not register as more than a passing inconvenience. [The U.S. GDP grew by almost 3% last year.]
As for the link to inflation, prices probably will go up. But will tariffs cause sustained inflation? If these are one-time increases, the inflationary effect may be quite fleeting.
Over the past seven years of tariff activism, the correlation of tariff revenues with inflation is practically zero.
On the other hand, tariff revenues do correlate moderately well with the Yuan/Dollar exchange rate, lagged by two quarters.
The other “behavioral” adjustments mentioned above will also tend to “dampen inflation estimates” (as the Boston Fed study puts it).
That Said
Things may well be “different this time” — for several reasons.
First of all, the Liberation Day shock factor is quite large. It envisions a high-tariff regime the country has not seen for almost a century, an abrupt shift after decades of relative tariff policy quiescence. Small changes can be cushioned and “absorbed” by equilibrium-seeking market mechanisms. Very large shocks can break things. In engineering terms, this may cause a transition from linear responses (smooth, orderly, predictable) to nonlinear responses (violent and unpredictable) which cause major changes in system behavior.
Second, there are important geopolitical concerns and implications associated with these new tariffs. If we are entering a period of a real “trade war” where tariffs as weaponized by both sides to achieve all sorts of non-economic objectives (immigration control, fentanyl suppression, decoupling from China, the Taiwan question), the response to tariffs becomes even more unpredictable.
Third, as noted, the natural offset to tariffs — compensating exchange rate adjustments — may be less powerful this time because so many countries are already operating with severely undervalued currencies. China in particular may not have the policy freedom to set its exchange rates much lower.
Finally, the violence of the Liberation Day reactions may jolt public inflation expectations upwards, which some at the Fed believe could ignite a more sustained inflation. According to the Conference Board “the average 12-month inflation expectations reached 7% in April — the highest since November 2022, when the US was experiencing extremely high inflation.”
It’s also good to keep in mind what is the most fundamental simplification of macroeconomic forecasting: these models average the effects of tariffs across an incredibly diverse economy, smoothing out the impacts on individual participants — and obscuring the fact that there will certainly be some winners and some big losers in all this. The pain will not be uniformly distributed.
My Best Guess
The tariff-inflation link remains for now a Known Unknown. Based on the murky findings of the studies cited in this column, my guess is that direct consumer inflation will be a minor consequence of the proposed tariff policies (if they are carried through). The larger impact will be a disruption of global supply chains, which may create shortages and temporary price spikes affecting specific products (think avian flu and egg prices), but it will not lead to sustained inflation.
At lot of this is broadly psychological – which makes it dangerous. The new tariff proposals have created huge uncertainties for businesses trying to navigate a global economy that is suddenly in an uproar, and it has injected raw volatility into the financial markets, which has unsettled the public. The psychological effects will probably outweigh the actual impact on prices. Inflation is likely to be one of the less important consequences of Liberation Day.
Further reading – see Part 1 of this series