I am a Tariff Man,” declares Donald Trump. But what about inflation? In his 2025 State of the Union, he admits There mightl be "a little disturbance, but we are OK with that. It won’t be much.
I'm less optimistic. To understand why, we need to look at the inflation that followed the end of the Covid pandemic. Although it began with supply-chain disruptions that were only transient, the resulting inflation had a distressingly long tail. Three lessons learned from that painful episode suggest that any inflation driven by tariffs on the scale Trump has promised will be more than a blip.
Lesson 1: Inflation has both a demand side and a supply side
A good place to start is a Panglossian view enunciated by Scott Bessent, now Treasury Secretary, in a December radio interview. “Tariffs can’t be inflationary,” explained Bessent, “because if the price of one thing goes up, unless you give people more money, then they have less money to spend on the other thing, so there is no inflation. … Inflation comes through either increasing the money supply or increasing the government spending, and that’s what happened under Biden.”
There is a smidgen of truth in that, but just a smidgen. Yes, inflation is caused by too much demand chasing too much supply. Yes, policymakers can moderate demand by using monetary and fiscal policy. But those tools works best if excess demand is the origin of the inflation in the first place. The post-Covid inflation was different. The latest studies show that demand played only a small role in the upward surge of prices that began in the winter of 2021. Supply-chain disruptions played a much larger role. Tariffs, too, would mostly cause supply-side inflation.
When faced with supply-driven inflation, whether caused by factory closings and shipping bottlenecks or by tariffs, it is not enough just to hold the line on monetary and fiscal policy. To fully control inflation, the Fed would have to substantially crank up interest rates, preferably while Congress cut spending and/or raised taxes. In that case, we might get the Bessent result in which decreases in some prices offset increases in others. But such a strategy would come at the cost of falling real output and rising unemployment – even a major recession. Not what Bessent had in mind.
