Tariffs

While the macroeconomic data appear consistent with the currency offset theory, academics studying goodslevel microdata take a harsher view of this experience.

Cavallo, Gopinath, Neiman and Jang (2021) study detailed microdata of goods imported by retailers.

They find that:

• the dollar import price moved up by the amount of the tariff
• the appreciation of the dollar did little to offset the tariffs

In other words, they argue that the move in the currency didn’t passthrough into import prices.

Similar conclusions are drawn by Fajgelbaum et al (2020) and Amiti, Redding and Weinstein (2019).

What can bridge the gap between the macrodata arithmetic and the results of microdata studies?

1. Examples like Cavallo et al tend to study short run effects.

It is possible currency passthrough into prices will be much slower than tariff passthrough.

It’s much less salient. Importers tend to hedge their currency exposures anywhere from a few months to a few years out.

If the importers hedge currency risk, it will take time for level shifts in the currency to pass through into invoiced prices.

It would be bizarre for any economist to think that passthrough will never occur, since a competitive marketplace will result in producers lowering prices to marginal cost.

If economists began to believe currencies didn’t affect the prices of traded goods, they’d have to reimagine several branches of economics.

Amiti et a (2018) refer to the lack of exchange rate passthrough as a “puzzle” and speculate that over a longer period, exchange rate effects will materialize.

2. Cavallo et al find that the price hikes occurred for prices paid by importers, not prices sold by retailers.

This limits the ability of tariffs to result in increases in consumer prices but squeezing margins.

That means that for the measures of inflation commonly prioritized, like the Consumer Price Index, or the price index for Personal Consumption Expenditures, there was little consequence.

That helps reconcile the micro-and macro experiences.

However, it would be bizarre for economies with sufficient competition not to see importers over time restore their margins by shifting suppliers if currency weakness isn’t passed through.

3. Interpreting goods-level microdata is difficult in light of re-export diversion.

To avoid the tariffs, many Chinese companies began exporting to third countries for minor processing to be re-exported to the United States.

Iyoha et al (2024) find that rerouting of Chinese imports increased by roughly 50% since the tariff increases.

Freeman, Baldwin and Theodorakoplous (2023) find that,

while just 8 More formally, because imports are invoiced in USD, the currency move doesn’t automatically affect the import price.

If imports are invoiced in USD and the dollar appreciates, foreign profit margins improve, and then over time competition should whittle that margin so that then the dollar-invoiced import price declines.

over 60% of manufacturing intermediates imported into the U.S. came directly from China, incorporating the value-added of manufacturing intermediates that originated in China but were imported from other trade partners brought that number above 90%.

The decision for Chinese exporters whether to evade tariffs via re-export is affected by the demand elasticity for their exports in the United States, introducing a critical bias into microdata studies. It is likely that the goods that are still directly exported to the U.S. and therefore subject to the tariffs are the ones over which the Chinese exporters retain the most pricing power and the greatest ability to pass through price increases on Americans. The goods on which Chinese exporters do not have pricing power, and over which they might have to absorb the tariffs, are the ones most likely to be re-exported via a third country.

Chinese exporters will not pay the cost of diverting exports if they can push through price increases on purchasers. This practice severely upwardly biases the results of the microdata studies: only those goods with the highest ability to foist increases on Americans continue to be labeled as “made in China,” and other goods receive minor processing elsewhere and get labeled as different origin.

In other words, difference-in-difference and related approaches will over-estimate the effect of tariffs on prices in microdata.

Nevertheless, let’s consider the results in Cavallo et al at face value, and suppose America puts a 10% tariff on all imports, per President Trump’s proposals. With complete passthrough, that would lead to a 10% increase in prices of imported goods in the United States. Further suppose the dollar behaves as in 2018-19 and appreciates by the same amount as the tariff, 10% on a broad basis.

Gopinath (2015) estimates that USD passthrough to imported prices is about 45% in the first two years, and that a 10% move in the USD impacts CPI by 40-70 basis points. Gopinath (2015) calculates that 6% to 12% of all consumption derives from imported sources, while Briggs (2022) estimates that number at about 10%.

With 10% of consumption from imported sources, 100% passthrough, and a 10% tariff, consumer prices will go up by one percentage point.

Incorporating the 40-70 basis point drag on inflation from the stronger dollar would indicate a total tariff passthrough into price levels of 0.3% to 0.6% of the CPI.

All else equal and in a calm economic environment, such a modest increase would be a one-time boost to the price level and thus transitory, rather than contribute to lasting inflation.

In more turbulent times and greater inflationary cross-currents, such a change may work its way into inflation expectations and become more persistent, contributing to a goods-wage inflationary spiral.

The economic context into which tariffs are levied will be of significant importance, and the fragility or robustness of inflation expectations and local supply elasticities at current macroeconomic equilibrium can play substantial roles. Certainly there was no indication in 2018-2019 of a goods-wage spiral.

If the currency markets adjust, tariffs can have quite modest inflationary impacts, between 0% and 0.6% on consumer prices. Given the inflation volatility of recent years, this is nontrivial, but hardly earthshaking.

Clearly, the experience of 2018-2019 was that there were only imperceptible increases on the general price level.

Moreover, the totality of tax reform, deregulation, and energy abundance can serve as meaningful disinflation drivers that smother any incipient inflationary impulses; it is quite possible that even with substantial tariffs, Trump Administration policy is overall disinflationary.

I will later turn to the likelihood of whether currency markets will adjust, as well as to the risks of retaliation, which can alter the tariff analysis.