


Not all bad economic policy is inflationary, and not causing inflation doesn’t make economic policy good.
B ack in March, I predicted that tariffs would have a negligible effect on inflation. Many news stories and plenty of commentary, including from the Federal Reserve, are now talking about tariffs causing inflation. This post is a fuller explanation of why I don’t expect tariffs to cause significant inflation — and why they’re still a bad idea.
Many people use the word “inflation” when they just mean to say that a price has gone up. This usage is sometimes fine in casual speech, but when economists use the term, they should insist on having a more specific meaning.
There are all kinds of reasons that a price can go up. Consumer fads, natural disasters, government regulations, government subsidies, transportation bottlenecks, and input cost increases can all cause prices to rise. None of these is “inflation,” as economists should use the term.
Inflation is an increase in the money supply that exceeds the increase in real output in the economy. It’s too much money chasing too few goods. Its result is that the purchasing power of a unit of currency decreases, in general, for the entire economy.
That’s not what tariffs do, nor is it what economic theory would expect tariffs to do. Bryan Cutsinger, a professor of economics at Florida Atlantic University, wrote an excellent piece for the Daily Economy walking through the economic logic step by step. I’m going to rely on parts of his analysis in this post.
Let’s begin with the quantity theory of money:
MV = PY
That’s the accounting identity at the foundation of macroeconomics. It says that the money supply (M) multiplied by the velocity of money (V) equals the price level (P) multiplied by real output (Y). It’s true by definition and has been known since before economics even existed as a field; Nicolaus Copernicus — the Earth-goes-around-the-sun guy — was an early writer on the quantity theory of money.
That equation is static. Do a little calculus, and it becomes dynamic. That’s what we want to think about inflation, since inflation is an increase in the price level, or a positive change in P. Cutsinger did the math for us:
Money Supply Growth + Velocity Growth = Inflation + Real Output Growth
That’s the change in M plus the change in V equals the change in P plus the change in Y. Same equation, same accounting identity, but dynamic instead of static.
Since inflation is what we’re interested in, Cutsinger rearranges it to equal inflation:
Inflation = Money Supply Growth + Velocity Growth − Real Output Growth
As Professor Garett Jones of George Mason University has said, if you have the fortitude to do just a little bit of math, there’s a really big payoff in understanding economics. This is a great example of that. Now, we have an equation that succinctly models the causation of a very complicated macroeconomic phenomenon in three broad concepts. Inflation goes up if money growth goes up, velocity growth goes up, and/or real output growth goes down.
“The question, then, is how do tariffs affect the components of the inflation equation?” Cutsinger writes. The answer, ultimately, is, “Not that much.”
Tariffs don’t directly relate to the money supply or money velocity at all. Cutsinger writes that velocity is related to interest rates. “How quickly people spend money depends, in part, on the opportunity cost of holding it,” he writes. “Economists typically measure this cost by the interest that could be earned by holding wealth in assets that yield a higher return than money.” That means if interest rates rise, the opportunity cost of holding onto money rises, so velocity would go up. But market expectations remain that interest rates will stay the same or fall in the coming months and years, suggesting that if anything, velocity will go down slightly.
The only way tariffs could affect the money supply would be if the Federal Reserve chose to react to them by altering monetary policy. “If the Fed is committed to hitting its inflation target, regardless of where price pressures come from, then it might feel compelled to tighten policy,” Cutsinger writes. But he notes that it matters where the price pressure is coming from, which is why it’s important to not be sloppy with the word “inflation.”
Cutsinger writes:
Tariff-driven inflation stems from a supply-side shock. Prices are rising not because people are demanding more goods and thus pushing prices higher, which can and sometimes should be offset by tightening the money supply. Prices are rising because the economy is producing less than it otherwise would. Changing the money supply cannot fix the problem of the economy producing less.
The “economy producing less” is another way of saying “real output growth goes down,” which, according to the inflation equation, is one of the causes of inflation. Tariffs certainly are expected to cause real output growth to fall. They are taxes that encourage less productive uses of resources and interpose government in beneficial business relationships.
To the extent that that happens, the inflation equation would predict higher inflation. But the extent at a macroeconomic level will likely be small. The tariff rates are high, but the U.S. has one of the least trade-oriented economies in the world. (At 25 percent, the U.S. trade-to-GDP ratio is third-lowest for any country with data available.)
There are also other factors, besides tariffs, that affect real output growth. Technological advances, in AI and elsewhere, could boost growth. Permanent full expensing for capital investments, a provision in the One Big Beautiful Bill Act, will have a positive effect on real output. Deregulation will help. None of these is a game changer, but, put together, they will probably be enough to mostly neutralize the real output drop from tariffs. Tax Foundation analysis basically says the tariffs and the OBBBA are a wash in terms of real output growth.
That doesn’t make tariffs good! It would be much better to just have the growth from the OBBBA and not have it be neutralized by tariffs.
Tariff supporters are trying to flex on free traders by pointing out that inflation didn’t happen during Trump’s first-term tariffs and that, so far, it isn’t going up in a major way in his second term. “My preferred economic policy doesn’t cause inflation” is just about the weakest argument possible. Not causing inflation is basically the bare minimum of what people want from economic policy.
Tariffs still make people poorer on average, not by reducing the value of the dollar in general but by reducing households’ after-tax income. They do this because they are a tax increase and because they cause price increases for the goods on which they are levied. They also have negative effects on overall employment, creating some jobs in preferred sectors but destroying jobs on net. Economic research is clear on this subject.
Tariffs encourage corruption and increase the return on lobbying, something populists should be especially alarmed about. Anything that causes lobbying spending to more than triple in a year is probably not a great policy.
And the way President Trump has chosen to conduct his tariff policy has been completely self-contradictory, reckless, confusing, illegal, and based on nonsensical narratives, formulas, and theories.
That’s all bad, but it’s not inflation. Economists and commentators should be more careful with the use of the word “inflation,” because it matters if prices are rising because of money supply growth versus some other cause. Tariffs are some other cause. And the price increases are only one of many reasons to oppose them.