Stagflation from higher tariffs: 1970s redux?

Summary

President Biden recently hiked tariffs on $18 billion worth of imports from China, and former President Trump has vowed to implement a 60% tariff on China and an across-the-board 10% tariff on other trading partners should he return to the White House in 2025. What effects would these tariff increases have on the U.S. economy?

Using a large macroeconomic model, we analyze four scenarios. The "baseline" scenario, in which tariffs are not raised, traces out the path of the economy from 2025 through 2029. We impose a 50% tariff on $18 billion worth of Chinese imports under the "Biden" scenario. In the "Trump" scenario we impose a 60% tariff on imports from China and an across-the-board 10% tariff on other trading partners. In the fourth scenario, we repeat the analysis of the "Trump" scenario but assume that foreign economies retaliate with their own 10% tariff on imports of American-made products.

The "Biden" scenario is essentially the same as baseline because tariffs on only $18 billion of Chinese imports simply do not move the needle in a $28 trillion economy. Under the "Trump" scenario, GDP growth downshifts significantly in 2025 relative to baseline, which causes the unemployment rate to rise half a percentage point more. Inflation is higher in 2025 under the "Trump" scenario relative to the baseline. If foreign countries retaliate with their own levies, then our projections show that U.S. GDP would contract next year and the jobless rate would move even higher.

The growth-reducing effects of the tariffs arise from their effects on the Consumer Price Index. Higher prices erode growth in real income, which leads to slower growth in real consumer spending. Monetary policy easing helps to cushion the blow to the real economy from the tariffs. That said, Fed policymakers may place greater weight on deviations of inflation from target than the model assumes. If so, real GDP growth could slow more and the jobless rate could rise higher than our simulation results suggest.

The so-called "Misery Index," which is the sum of the CPI inflation rate and the unemployment rate, rose from 9% in 1972 to more than 20% in 1980 due to the oil price shocks of the 1970s. The unemployment rate and the inflation rate would both increase if tariffs rise meaningfully, but the sum of these two variables likely would remain well-below the highs that were reached in the late 70s/early 80s. In short, tariff increases would impart a modest stagflationary shock to the economy.

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