What impact do tariffs have on the economy, really?
According to experts from the Federal Reserve Bank of San Francisco, the answer is more nuanced than their proponents—and detractors—would have people believe.
Many consumers have been bemoaning higher prices for some time now. But research by the bank’s senior policy advisor, Òscar Jordà, and the vice president of its economic research department, Fernanda Nechio, indicates that the line connecting tariffs to inflation is more serpentine than straight.
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In a white paper released Monday, the researchers outlined the results of research into 40 years of international economic data. It showed that, generally, after a change in tariff rates, unemployment tends to increase while inflation declines. But over time, labor levels stabilize and inflation ticks up.
“This pattern suggests that, at first, the effects of tariffs more closely resemble a negative demand shock—that is, consumers and businesses pull back their spending, which slows economic activity and also slows down inflation,” they wrote. “Over time, however, economic activity picks up and inflation increases to a higher rate than would have been the case without the tariff increase.”
That may be the prevailing trend, but the economy doesn’t thrive on rules. There are many mitigating factors that determine tariffs’ impact on economic activity, according to FRBSF.
Generally, tariffs increase the price of imported goods, but that one-time bump could be a temporary hindrance to shoppers as long as the new tariff rate remains stable. However, stability isn’t a guarantee, as evidenced by the current administration’s mercurial trade strategy.
The supply side must also be considered, as businesses may rejigger their supply chains based on their perception of the tariffs’ future impact, leading to changes in pricing. Importers could also choose to shield shoppers by eating the cost (or most of the cost) of the tariffs themselves, leaving consumers’ experiences largely unchanged.
Those decisions are often influenced by perceptions of what trade policy will look like over the coming years, and in 2025, that kind of certainty is hard to come by. In the short term, though, if consumers clock higher prices at retail, they may opt to change their spending habits or tighten their purse strings, having an immediate effect on the economy.
“Any of these responses by businesses and consumers will depend on how permanent or transitory tariffs are perceived to be, possible retaliation by trading partners that may affect exporting industries, and general uncertainty associated with subsequent trade agreements, legal decisions, and other factors,” the researchers wrote.
None of these factors are particularly predictable, especially when recent U.S. trade policy “has sharply reversed a worldwide historical decline in tariffs,” they added. Tariff rates have declined steadily over the past six decades—until now.
Using a modeling tool dubbed “local projections,” the researchers examined the long-term evolution of unemployment, consumer price index (CPI) inflation and tariff rates following a 1 percent change in the average tariff rate. They constructed two projections on the path of unemployment—one using information on changes in tariffs and the other without. They did the same with inflation.
According to the statistical method, a 1 percent raise in the tariff rate increases unemployment by about 10 basis points (one-tenth of a percentage point). A 10 percent tariff increase would therefore yield a 1 percent surge in unemployment, and so on. Over the second year of tariffs, the unemployment rate levels out, and then over the ensuing two years, it declines slightly.
Meanwhile, the model showed that inflation declines about 10 basis points per 1 percent increase in tariffs at the time that the tariffs change (meaning a decline of 1 percentage point per 10 percent increase in tariffs). However, by year one, the deflationary effect dissipates, and inflation accelerates in the opposite direction—about 10 basis points per 1 percent increase in tariffs over the ensuing two years. That effect only starts to dissipate by year four.
“The initial increase in the unemployment rate together with the drop in inflation both suggest that tariffs act like a brake on the demand side of the economy,” the researchers explained. “Firms may withhold investment spending until there is more clarity on future trade policy, since tariff policies will prompt them to reconsider how they arrange their supply chains.”
At the same time, shoppers may respond with trepidation to the changes in employment and pricing, mostly by pulling back on purchases of products and services. “Over time, the economy adjusts: The unemployment rate returns to its original level or even declines slightly, whereas inflation picks up and peaks three years after the initial change in tariffs, relative to the scenario where tariffs remain unchanged,” the report said.
However, given that “[t]he tariffs recently enacted are unprecedented in magnitude and scope,” Jordà and Nechio wrote, “[o]ur estimates should be interpreted with caution.” Historical data on tariffs doesn’t contain the kind of big swings in the tariff rate being seen today, making it hard to predict what the current tariff regime could portend for both the supply chain and shoppers.
“Ultimately, our results show that the effects of tariffs on the economy do not go in a single direction. On impact and early on they depress labor markets and inflation. Over time these effects reverse course,” they wrote. “In other words, it seems that demand factors prevail in the short run but supply factors dominate in the long run.”
Monetary responses to tariffs tend to be delayed, so “[it is important to understand the timing of the different effects of trade policy on the economy” before trying to mitigate impacts, they concluded.
