Trade policy is the new monetary policy
A recent report from the San Francisco Fed highlights a shift towards using tariffs as a macroeconomic strategy, a concept that hasn’t been fully explored by many economists.
Research by Regis Barnichon and Ayush Singh, covering 150 years of data from the United States, United Kingdom, and France, reveals that higher tariffs can lead to increased unemployment and reduced inflation. This indicates that tariffs can function similarly to tax increases and monetary policy adjustments. Hence, we should reconsider how tariffs fit into our economic strategies to prevent a potential collapse.
Moreover, this discovery suggests that governments must rethink their approach to tariffs. If tariffs consistently affect inflation and unemployment, then we should treat them as a dynamic, data-driven tool that’s primarily handled by civil authorities.
Understanding the customs toolkit
Now, let’s look at some straightforward realities regarding the San Francisco Fed’s findings. Historically, significant increases in tariffs have led to job losses and reduced inflation across various countries. This tells us two key things: first, tariffs aren’t just isolated distortions; they significantly impact economic aggregates. Second, their effects seem to mirror those of monetary and fiscal tightening, resulting in falling prices and rising unemployment.
Even if we observed similar outcomes following a rate hike, few would argue that “Prices are unethical and should never change.” Some might counter, “Interest rates are a macroeconomic tool, and we must consider how best to use them.”
Tariffs should be examined in a similar light. Instead of viewing them as taboo or as indicators of one’s stance on free trade, they should be recognized as instruments that influence inflation and employment. Viewing them this way leads to some logical guiding principles.
Data-driven tariff decisions
If tariffs have macroeconomic effects, then the tariff schedule for the next 20 years shouldn’t be set in stone. Rather, it should be flexible and responsive to economic conditions.
Barnichon and Singh’s analysis suggests a straightforward principle akin to the Taylor rule. Specifically, when inflation is high and unemployment is low, tariffs can serve as a tool for controlling inflation without significant job losses. Conversely, when unemployment is high and inflation is low, increasing tariffs may not be effective and could push the economy into a recession.
Hence, a general guideline for workers is emerging: When unemployment is low and inflation is high, tariffs are likely too low.
If unemployment is high and inflation is low, tariffs may be excessively high.
This all points to the importance of being data-driven. We shouldn’t rigidly adhere to pre-determined tariff limits, especially when economic conditions fluctuate.
If we allow the Federal Reserve to adjust interest rates per meeting, why should tariffs remain static during varying economic cycles?
Dynamic tariff adjustments
Another significant point this study makes is historical; tariff changes over the past 150 years haven’t aligned closely with business cycles. Political motivations have often dictated tariff adjustments, sometimes leading to unintended economic experiments. This historical context provides a foundation for understanding causality.
The takeaway isn’t that we should avoid changing tariffs altogether; rather, we should be cautious in how we implement adjustments.
Given that tariffs can influence inflation and employment, they should be adjusted intentionally and frequently. If prices are escalating and the labor market is tight, tariffs should be increased. If unemployment rates rise, leading to a need for job creation, tariffs should be lowered.
Dynamic tariffs aren’t a far-fetched idea. We already modify interest rates regularly, update regulations based on crises, and adjust energy policies following price spikes. However, tariffs are often seen as set in stone after trade agreements, which shouldn’t be the case. This SF Fed report strongly suggests that we stop treating tariffs as static.
Discretion in tariff policy
When asserting that tariff policies should respond to current data, it follows that they must allow for a degree of discretion.
It’s impractical to write a law that specifies automatic tariff increases based solely on numerical thresholds for unemployment and CPI. The challenges of real-world economic shocks mean that decisions about tariffs must be contextual, considering various factors including immigration and tax policies.
Such nuanced decision-making is closely aligned with the responsibilities of elected officials.
Congress, however, is ill-suited for this task. Legislation surrounding tariffs tends to be slow and often influenced by political maneuvering. International agreements could complicate matters further, tying the country to long-term schedules based on outdated economic conditions.
If tariffs respond to economic data (i.e., unemployment and inflation) and are dynamic (subject to change based on conditions) and discretionary (considering other economic policies), then the executive branch must oversee them.—while still aligning with legislative oversight, but the practical authority would lie primarily with the White House.
Essentially, this points to a reconciliation of a model similar to what Trump utilized, granting significant tariff authority under existing laws based on immediate economic and geopolitical needs, rather than only viewing it as a rare adjustment to established agreements.
Integrating tariffs with Fed policy
If tariffs reliably decrease inflation and increase unemployment, they should be regarded as an integral part of the Federal Reserve’s operational strategy, rather than in opposition to monetary policy.
A strategic balance could involve the President using tariffs (alongside immigration and tax policies) to influence production and distribution, while the Fed uses the data from tariffs to adjust interest rates. If a tariff is imposed that raises inflation and slows growth, it would be prudent for the Fed to ease rate tightening, not exacerbate it.
All of this hinges on the need to abandon the misconception that tariffs are merely about trade. The San Francisco Fed summarizes well: Tariffs have historically played a role in controlling inflation.
Recognizing this, the logical next step is to incorporate tariffs into a broader macroeconomic toolkit, applying real-time, data-responsive adjustments, rather than safeguarding them under an outdated narrative.
