Tariffs trigger economic contraction and inflation, monetary policy reacts

A Banque de France study provides robust empirical evidence on the macroeconomic effects of U.S. import tariff shocks, analyzing data from 1990 to 2024. The research confirms that tariff shocks are consistently contractionary and inflationary, with monetary policy partially accommodating these effects.

A 1 percentage point increase in the U.S. import tariff rate leads to a delayed rise in CPI inflation, peaking at 0.78 percentage points after 11 quarters.

Concurrently, real GDP experiences a faster decline, reaching a trough of -1.23 percent after only six quarters.

This empirical contribution fills a significant gap, as previous studies have presented conflicting results.

While some found tariffs expansionary or deflationary, this study's findings align with the view that tariffs are both contractionary and inflationary, and it discusses reasons for these discrepancies.

The study estimates how tariff shock effects depend on systematic monetary policy responses, without relying on a fully specified structural model.

For perfect price stabilization, the federal funds rate rises sharply by 0.82 percentage points.

This limits inflation to a modest 0.21 percentage point peak (four times smaller than baseline), but causes a substantial real GDP decline, 0.44 percentage points lower at the trough (36 percent reduction).

For strict output stabilization, the federal funds rate is lowered more aggressively, reaching a -2 percentage point trough.

This mitigates recessionary effects but substantially amplifies inflation, with the peak effect almost twice as large as in the baseline.