Tariffs Do Cause Inflation
I am beyond disappointed in folks on the Right who spout what they must know -- or at least knew 6 months ago -- to be economic drivel. It has been a rough ten years as a libertarian -- first abandoned by our natural allies on the Left on issues like Free Speech and now abandoned by our natural allies on the Right on free markets.
Conservatives are saying that criticism of Trump's tariffs causing inflation are overblown because there was not much inflation in April and May. But the reality is that the vast majority of companies have not modified prices to take into account tariffs on their inputs. One reason is that the on-again-off-again nature of these Trump tariff proposals have caused companies to hold their prices for now, eating any cost increases in their profitability but hoping the tariffs will go away (update: PPI Shows Companies Eating Tariff Costs, Bloomberg Finds). No one wants to lose market share by being the first to raise prices (think of Apple vs Samsung on phones, for example). If it becomes clear that tariffs are here to stay in some sector, then you will start to see price increases because companies may eat the costs for one quarter but cannot do so indefinitely.
Here are my two predictions if the tariff uncertainty continues
- You are going to see some shortages of product this Christmas. My son works for a major retailer that imports a lot of product and they are struggling with Christmas ordering, which basically has to happen now but is being bought at forward prices that, given tariffs, no one can guess at. I think the net will be reduced buying, lower retail sales, and higher prices this Christmas
- Manufacturing investment is going to start falling. It has already flattened somewhat and I would expect 2Q and especially 3Q to be down. Like many economic indicators, there is a lot of lag -- spending this quarter was likely approved and planned long before Trump every got into office. But the crazy shifting tariff situation makes it impossible to plan one's supply chain and manufacturing strategy. My guess is that everyone is going to hold off spending until things are clearer. As to Trump's arguments that the whole point of tariffs is to spur manufacturing investment, most US manufacturers can't get the labor they need already. It's not clear many companies have realistic re-shoring options.
3. We'll see a falling dollar that'll increase import costs in addition to potential tariffs
I don't think the headline is right - that tariffs cause inflation. We need to distinguish between prices (relative prices) and the price level.
Tariffs cause prices (relative prices) for imported goods affected by the tariffs to increase, but they can't cause all prices to increase. All prices (the price level) can increase only if the money supply increases. John Cochrane goes into great detail on the difference at https://www.grumpy-economist.com/p/inflation-and-the-macroeconomy.
This is not to defend tariffs. Tariffs are bad because they suppress trade. Trade is good because it increases prosperity for both sides of the trade. Less trade necessarily means less prosperity. There could sometimes be cases where there are political advantages from restricting trade - this is the logic behind US export controls, which are designed to prevent rivals from gaining access to US technology, or to prevent odious regimes from getting access to weapons of mass destruction or means of surveillance. But even in these cases, the people who could participate in the trade would gain.
Tariffs can cause one-time price increases in selected sectors but don't cause "inflation".
Inflation involves prices increasing continuously over time. Month after month, year after year. Tariffs don't do that. The reason to oppose tariffs isn't - or at least shouldn't be - that anyone expects them to cause a measurable increase in inflation.
Let's ignore macro "money" supply factors for a bit and just think in terms of prices:
Suppose 10% of our economy is imports and a new 10% tariff raises the cost of those imports. In the very short term people continue buying the same goods as before of which 10% got 10% costlier which suggests a one time short-term rise in the overall price level by a total of 1% (.1 * .1). But shortly after that people *adjust their behavior* in response to the higher prices. Imports having gotten more expensive, people adjust consumption levels, consume fewer imports, the share of our economy that involves imports declines - let's say it drops from 10% to 5% - and the effect on the price level declines. Now prices across the whole economy are only 0.5% higher than they were. So price levels saw a bump followed by a correction and are flat thereafter - there's no PERSISTENT inflation.
But that's ignoring the macro stuff. If you bring macro back in you don't even get that initial bump! The fact that people are spending MORE on imports means they're necessarily spending LESS on something else. Unless the government prints more money the overall price level should actually be about the same as before.
Tariffs are still bad, but not because they cause "inflation".