Incessant inflation’s return has been everyone’s most important economic challenge, forcing policymakers into a dangerously confusing cacophony of diagnosis and cure. While factors like global supply chain disruptions, the Russian invasion of Ukraine, increases in the money supply, low interest rates, and high demand all play a role, one often-overlooked contributor deserves a closer look: tariffs. Despite appearances, I’m not trying to pick a fight with the USTR—I too share the strong belief that tariffs are inflationary. They increase the cost of all imported goods, which impacts consumers instantly.
Tariffs raise the cost of those imported goods for American consumers and businesses. This is not some arcane rule; this is a direct and unavoidable consequence. When the government adds a tariff, the cost of bringing a product into the country shoots up. Usually, that increased expense is then transferred to the final customer. This very basic mechanism drives up inflation; consumers pay more for the exact same products.
Now imagine that same U.S. company was importing steel to help produce those cars. If a 25% tariff is placed on imported steel, the company’s cost of production goes up dramatically. In order for the car maker to remain profitable, the automaker has to raise the price of the vehicle. This decision will fuel further inflation in the auto market and beyond. This multiplier effect sends ripples throughout the economy. Industries that rely heavily on steel—such as construction and appliance manufacturing—are now faced with added costs.
The effect of tariffs on inflation is not a theoretical debate. A 2021 review by economists Pablo Fajgelbaum and Amit Khandelwal concluded that "US consumers of imported goods have borne the brunt of the tariffs through higher prices." This troubling finding illustrates the clear link between tariffs and additional costs passed directly to consumers. More importantly, it illustrates how average citizens consistently end up paying the price for protectionism.
Most importantly, we need to recognize that tariffs are frequently mischaracterized as simple, benign tools to protect domestic industries from foreign competition. This protectionist argument holds that tariffs can offset unfair advantages to help level the playing field and promote more domestic production. As you’ll soon see, the story is much more complicated. Tariffs may be a political move, offering momentary safety to targeted industries. Frequently, they incite retaliatory measures from foreign countries, escalating the tensions into full-fledged trade wars.
Trade wars, marked by a tit-for-tat increase in tariffs and other trade barriers, can wreak economic havoc far beyond the nations directly involved. As countries retaliate with their own tariffs on each other’s goods, international trade further erodes, supply chains are broken, and prices rise. This cycle of escalation is hurting consumers and small businesses alike, increasing inflationary pressures.
In the past, the United States has seen the inflationary impacts of tariffs up close. The Tariff of 1816 was worse, raising average rates to 35%. This was followed by a meteoric rise in prices — hyperinflation, as some would call it. Likewise, the 1918 Tariff, which raised rates to an average of 31.2%, increased prices. Though tariffs have at times proven effective as a bargaining chip in trade deal negotiations, we cannot overlook their power to stoke inflation.
Tariff proponents argue that tariffs decrease consumer purchasing power and decrease demand, thereby cooling inflationary pressures. The rationale behind this is that higher tariffs lower after-tax incomes, thereby increasing the negative effect on purchasing power. This argument fails to account for the near-term effect that a tariff has on prices. Decreased demand would eventually take some of the excessive inflationary pressure off the economy. The first order effect of tariffs is unambiguously to increase consumer costs.
Additionally, the consequences of a tariff are not equal across all goods being targeted and across different levels of tariffs. For example, estimates suggest that a 25% tariff on goods from Canada and Mexico, and 10% on China, could increase inflation by 0.5 to 0.8 percentage points. The worst-case scenario would be for a 60% tariff with China and a 10% tariff on the rest of the world. This increase will push inflation up by 1.4 to 2.2 percentage points. Together, these figures illuminate the substantial potential for these harmful tariffs to worsen tariffs to fuel inflationary pressures.
As an analyst, I have the background of global economics, the reality that so many factors are affecting inflation. From my analysis, it’s pretty obvious that tariffs are a direct cause of increasing prices. While they may have other justifications, like defending growing domestic industries, their inflationary impact cannot be overlooked.
As the bipartisan inflation-fighting quest continues, the full impact of tariffs should be at the forefront of policymakers’ minds. As easy as protectionist measures might be to embrace in this moment, their unintended consequences will hurt American consumers and stall economic growth. A more effective approach involves addressing the underlying causes of inflation, such as supply chain disruptions and excessive money supply, while promoting free and fair trade.
At OverTraders.com, our mission is to empower today’s traders and investors with insightful analysis of financial and commodities markets. Knowing how tariffs are affecting inflation will help investors make better investment decisions. By staying abreast of economic trends and policy changes, we can navigate the complexities of modern markets and identify opportunities for growth.
At the end of the day, fighting inflation is a complicated endeavor. Tariffs certainly have a place in some economic strategies, however, their inflationary effect deserves serious thought. By prioritizing policies that promote free trade, address supply chain issues, and manage monetary policy effectively, we can create a more stable and prosperous economy for all.
