When Tariffs Don't Behave Like They Should

Here's something that might upend your understanding of how tariffs work: they could actually lower inflation. At least that's what two San Francisco Fed researchers found after digging through 150 years of tariff history.

The study, conducted by Régis Barnichon and Aayush Singh, suggests that tariffs lead to reduced economic activity, higher unemployment, and—counterintuitively—lower inflation in the short term. That's pretty much the opposite of what standard economic models tell us should happen. Conventional wisdom says tariffs increase the Consumer Price Index because imported goods cost more.

So what's going on? The researchers offer two potential explanations. First, tariffs might create enough uncertainty to rattle consumer and investor confidence, which then depresses economic activity and keeps inflation in check. Second, tariffs could trigger a drop in asset prices that further dampens demand, leading to higher unemployment and subdued inflation.

"Instead, tariff shocks appear to act as aggregate demand shocks—moving inflation and unemployment in the same directions," they wrote.

The historical data is striking. Before World War II, a permanent 4-point increase in tariff rates lowered inflation by 2 percentage points and increased unemployment by roughly 1 point. Post-war estimates are less precise, but they still point in the same direction: higher tariffs tend to push inflation down and unemployment up.

This matters because it challenges a lot of current assumptions. Last June, Federal Reserve Chairman Jerome Powell blamed President Donald Trump's tariffs for inflation—a stance that sparked considerable debate among analysts.

The Politics of Price Pressures

These findings actually line up with what some economists predicted earlier. Back in October, LPL chief economist Jeffrey Roach suggested that U.S. companies were more likely to absorb tariff costs rather than pass them on to consumers, which could reduce inflation risk and influence Fed policy.

The timing of this research is particularly interesting. Just days ago, Trump rolled back tariffs on several agricultural imports, including beef, coffee, and bananas, in response to concerns about rising prices.

Bernard Yaros, lead U.S. economist at Oxford Economics, noted on Friday that Trump's tariff rollback will have minimal impact on inflation since imported food represents only 10% of U.S. household consumption. But the move appears to be a clear response to cost-of-living concerns that could prove decisive in the 2026 midterm elections.

Bank of America strategist Michael Hartnett noted that a fall in inflation to 2% could lift Trump's approval above 45%, while inflation closer to 4% could push his rating below 40% ahead of the 2026 midterms. September's CPI report showed headline inflation rising to 3% year-over-year, just under the 3.1% forecast. Core inflation eased from 3.1% to 3%, with a modest 0.2% monthly gain—also softer than expected.

The bottom line? Tariffs might be more complicated than anyone thought, and their effects on the economy could matter quite a bit come election time.