Tariffs Do Cause a Slight Temporary Increase in Inflation

By David Henderson. 

"Don Boudreaux writes:

Unlike you who find Duncan Braid’s May 6^th harangue against supporters of free trade “devastating,” I find it to be tendentious. Braid writes triumphantly as if he’s caught us free traders in yet another of our Keystone Kops antics – specifically here, our effort to blame tariffs for inflation. Yet no competent economist or advocate of free trade is guilty of this ridiculous charge. If one were, Braid’s evidence of free-traders’ belief that tariffs cause inflation would consist of more than single link to a piece in, of all places, Vox.

If inflation means an increase in the money supply, then no, tariffs don’t cause inflation.

If inflation means a higher persistent growth rate of the price level, then no, tariffs don’t cause inflation.

But if inflation means an increase in the price level, then yes, tariffs do cause inflation.

One of the equations I’ve found most useful in understanding macroeconomics is MV = Py. (M is the amount of money, whether M1, M2, or some other M; V is the velocity of money; P is the price level; y is real income.)

Adding a tariff makes the economy less efficient, making real income lower than otherwise. Imagine that a lot of tariffs are added and that, as a result, real income is 0.5 percentage points lower than otherwise. That’s a lot, by the way. Then, if M and V are unaffected, the price level, P, will be 0.5 percentage points higher than otherwise. QED.

Does this mean that adding tariffs is a major cause of inflation? Of course not. 0.5 percentage points in a given year (the year the tariffs are added) is a small fraction of the 3 or 4 percent inflation rate. 0.5 percentage points, on top of 3 years of inflation averaging more than 4 percent annually, is rounding error."