Let’s hope the rates are inflationary

David Henderson has an excellent post on the effect of tariffs on price levels. I agree with his analysis, but here I will reframe the debate in a way that I hope will also be useful. Let’s start with a few statements:

1. Under the vast majority of policy regimes, imposing tariffs leads to a higher price level. These include the current (asymmetric) flexible average inflation regime (FAIT), but also the gold standard, the money supply target and the nominal GDP target.

2. There are a few policy regimes where rates are not inflationary, including price level targeting and symmetric FAIT. I don’t know of any country that has either regime.

3. Tariffs reduce real output. So if the monetary authority prevents any increase in the price level, the NGDP would fall. This would cause a rise in unemployment beyond the unemployment caused directly by the rates.

If a politician tells you that his tariff proposal won’t cause inflation, and if you believe him (yes, I know…), then you should be very concerned. That would mean that the tariff plan would be combined with a monetary regime that caused the welfare losses even bigger than usual.

Do Tariffs Cause Inflation? Let’s hope!

P.S. The best argument against tariffs is not that they cause inflation, but that tariffs cause lower real output.