Would former President Donald Trump’s proposed new tariffs especially on Chinese goods reignite inflation?
Many opposing Trump, the tariffs or both insist a new round of tariffs would be inflationary. Those making this argument are mostly wrong. While valid arguments compete on both sides of the tariff debate, the inflationary aspect should be set aside.
To be sure, the inflationary potential of new tariffs is superficially intuitive. But the intuition is wrong, resting on two misunderstandings relating to inflation itself and to the oft-ignored yet crucial concept of relative prices.
The inflation environment results from the monetary policy of the recent past and to a far lesser extent on current specific economic conditions. The Biden inflation surge resulted from the Federal Reserve running a loose monetary policy for too long.
The surge subsided when the Fed tightened and inflation will return to its 2% target as long as a restrictive policy continues long enough.
Inflation’s basic trajectory firmly reflects monetary policy, but against this monetary background, current events can temporarily accelerate or slow inflation relative to trend. To affect near-term inflation, however, such events must be substantial in intensity and affect a wide swath of the economy.
Good examples would be a spike in world oil prices due to a new Middle East conflagration or a breakdown in global supply chains causing widespread shortages.
However, even such large shocks have only temporary consequences for inflation.
If the price of oil shoots up, creating a new inflationary impulse adding to the inflation’s trajectory from monetary policy, then the reverse occurs when oil prices recede again, creating a deflationary impulse subtracting from underlying inflation. Likewise, the pandemic’s global supply-chain disruptions caused widespread price spikes, but as supply chains normalized, the spikes reversed.
Even if the initial shock persists rather than reversing, the effect is a temporary, one-time inflation impulse following which inflation would revert to its previous trajectory. Yet even this one-time boost would eventually be reversed.
If the price of oil shoots up, this is ultimately a relative price shock. The price of oil rises relative to other prices. Likewise, oil-intensive goods and services’ prices would rise relative to the prices of goods and services using little oil. For example, chemical manufacturing typically uses petroleum as feedstock, so when oil prices jump, chemical prices tend to rise relative to other prices like milk and massages, neither of which is oil-intensive.
A relative price shock means some prices rise faster than otherwise. But if monetary policy has not changed, then the underlying inflationary trend for all goods and services collectively does not change. For the overall trajectory to remain unaffected while some prices rise a bit faster, some prices must rise a bit slower. Markets eventually work through all the pushes and pulls but the bottom line is that upward relative price shocks do not accelerate inflation beyond a possible initial bump.
This is the proper framework for considering Trump’s proposed tariffs. To some extent the tariffs would be absorbed by the Chinese and the rest would be passed forward in higher prices.
Aha! The tariffs would be inflationary, you think.
No, the higher prices Americans faced from Trump’s proposed tariffs would represent an upward relative price shock operating through Chinese imports. And, as producers and consumers adjusted, the relative price shock would wash out of the overall price level.
Inflation is not an issue when debating Trump’s tariff proposals.
J.D. Foster is the former chief economist at the Office of Management and Budget and former chief economist and senior vice president at the U.S. Chamber of Commerce. He now resides in relative freedom in the hills of Idaho.
The views and opinions expressed in this commentary are those of the author and do not reflect the official position of the Daily Caller News Foundation.
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