David Henderson has an excellent post on the effect of tariffs on the price level. I agree with his analysis, but here I’ll reframe the debate in a way that I hope will also be helpful. Let’s begin with a few propositions:
1. Under the vast majority of policy regimes, the imposition of tariffs leads to a higher price level. These include the Fed’s current (asymmetrical) flexible average inflation targeting (FAIT) regime, but also the gold standard, money supply targeting, and nominal GDP targeting.
2. There are a few policy regimes where tariffs are not inflationary, including price level targeting and symmetrical FAIT. I know of no country that uses either regime.
3. Tariffs reduce real output. Thus if the monetary authority prevents any rise in the price level, then NGDP would decline. This would cause a rise of unemployment above and beyond any unemployment directly caused by the tariffs.
If a politician tells you that his tariff proposal will not cause inflation, and if you believe him (Yes, I know. . . ), then you should be very worried. That would mean that the tariff plan was to be combined with a monetary regime that made the welfare losses even larger than otherwise.
Do tariffs cause inflation? Let’s hope so!
PS. The best argument against tariffs is not that they cause inflation, rather it is that tariffs cause lower real output.
