Recent Study on Federal Reserve Tariffs Faces Criticism
A recent analysis from the St. Louis Federal Reserve claims that tariffs imposed during President Trump’s term have raised consumer inflation by around 0.5 percentage points. This study, shared on the bank’s On the Economy blog, employs advanced econometric modeling to examine how tariffs influence consumer prices.
However, there’s a significant flaw in the study. The findings do not support the idea that tariffs drive inflation. In fact, the same data can be interpreted to suggest that tariffs might actually help lower inflation by keeping prices of non-tariff items in check.
The Fed researchers compared price movements across categories that faced varying levels of tariff exposure. This involves a regression methodology that economists often use. They evaluated how much prices increased in different categories, especially for those heavily impacted by tariffs—like furniture and electronics—with larger price hikes noted than in those less affected by tariffs.
From these observations, they concluded that tariffs lead to inflation. Yet, the data indicates otherwise. What it genuinely suggests is that tariffed goods are rising relative to non-tariff goods.
The researchers interpreted this relative pricing change as a sign that tariffed items are straying upward from their “correct” price levels. However, the same data could just as easily support the perspective that non-tariff goods are deviating downward. It’s plausible that tariffs have increased prices for some products while lowering them for others.
Overlooked Fiscal Factors
There’s solid reasoning to believe non-tariff goods are indeed deviating. Tariffs elevate import costs but also boost government revenue and reduce the deficit.
Standard macroeconomic theory, as employed by organizations like the Congressional Budget Office, posits that deficit reduction is disinflationary in the short term since it dampens overall demand. As demand decreases, prices tend to fall. The most responsive category to domestic demand fluctuations? Service industries. These products are less likely to face international competition and carry a low tariff burden.
Thus, one might expect the fiscal channels to accurately predict the Fed’s regression findings: Prices of non-tariff items would remain below the trend due to fiscal constraints, while tariffed items would experience offsetting pressures—higher costs alongside lower demand—eventually aligning closer to the trend.
The researchers neglected to account for fiscal impulses and deficit reductions. They overlooked how customs revenue impacts demand, missing a crucial part of what economists refer to as general equilibrium.
The Flawed “Short Horizon” Argument
A memo from the Federal Reserve cited by the St. Louis Fed justification, stated that it’s reasonable to disregard downward pressures on non-tariff goods in the short term.
But why is this downward pressure “safely” overlooked? If the effects of tariffs can escalate prices in six to eight months, shouldn’t fiscal shifts also affect prices in that time? It seems the researchers have opted for an asymmetric view of price dynamics that conveniently supports their chosen narrative.
Sure, economists sometimes say, “Prices rise like a rocket but fall like a feather.” But that perspective feels outdated in today’s market realities, where prices can adjust quickly based on demand in either direction.
Many of the retailers dealing with tariff-impacted products also sell non-tariff items. Companies like Walmart, Amazon, and Target do not set prices in isolated categories. Instead, they manage pricing across thousands of products at once. If a store like Best Buy experiences lower traffic, it might increase prices on restricted items while reducing them on others to draw in customers. These decisions happen simultaneously.
The notion that tariffed items take one to eight months to react, while non-tariff goods remain unchanged, seems empirically irrational—especially since these items are literally shelved together and are governed by the same pricing strategies. Strategic pricing suggests that even if the Fed’s analysis shows tariffs inflate costs, the overall impact on consumers could remain neutral.
Phrasing it differently, the Fed’s researchers appear to employ a single inflation measurement. They evaluate inflation based on price changes at the category level combined with spending weights. This produces a “total contribution” from items impacted by tariffs, yet fails to account for the potential disinflation in categories less affected by tariffs. Consumer shifts in spending could offset the impact entirely.
So, they might simply be recording a redistribution of inflation across categories, rather than a net increase in overall prices. A straightforward robustness check—comparing the price changes of high tariff-exposed items with low ones—would reveal if headline inflation has genuinely risen or is merely skewed towards specific categories. Yet, that comparison wasn’t conducted.
Consistent Findings from Fed Researchers
This isn’t the first time Fed researchers have released analyses questioning the Trump administration’s trade policies regarding inflation, and likely won’t be the last.
However, this particular instance stands out due to its particularly glaring methodological errors. The issues are not subtle. The researchers operate with one equation and two variables, resolving it by assuming one of the unknowns to be zero.
It’s important to clarify that, at least in the short term, tariffs can raise costs for certain imports, which can then be passed on to consumers. But whether this leads to higher inflation overall is dependent on numerous factors beyond just tariffs, and the Fed’s model doesn’t clarify that.
The Fed’s own data supports various conclusions: tariffs could either boost inflation, lower it, or have no impact at all. Their regression doesn’t provide a clear answer. Nevertheless, commentators will likely reference this study as evidence that tariffs are driving inflation.
