Do tariffs raise inflation?

I was reading an article in the Economist (click here) about Trump's tariffs and its potential impact on US inflation. I'm going to be honest; I don't know much about tariffs and I don't know what Trump is planning. So... let's be really cool and go and read about it and share it on here...

Summary of the article...

Tariffs often raise inflation but their broader impact is more concerning, as they harm economic growth and stifle innovation. Donald Trump’s enthusiasm for tariffs echoes that of President McKinley, a 19th-century advocate of protectionism. Trump’s proposed tariffs, including sweeping levies on imports from China, Canada, and Mexico, are justified by claims that they boost American manufacturing and fund tax cuts. However, evidence suggests tariffs primarily increase prices, as companies pass on costs to consumers. While tariffs can strengthen the dollar by reducing imports, this impact is limited and short-lived, often harming exporters as American goods become more expensive abroad.

Tariffs also risk retaliatory measures from trading partners, further disrupting trade flows and leaving American households with little relief from rising prices. Although tariffs may not cause sustained inflation, they erode spending power and skew demand towards less efficient domestic producers. This "deadweight loss" distorts the economy, leading to wasted resources and lower incomes. Additionally, tariffs discourage innovation by shielding firms from competition and fostering exploitation of loopholes. Historical lessons from McKinley’s later policies, which recognised the value of reciprocal trade, highlight the economic dangers of commercial wars—lessons Trump appears to overlook.

Key takeaways from the article

Tariffs Often Raise Prices: Tariffs typically lead to higher costs for consumers, as businesses pass on the added expenses. This can cause short-term inflation and erode consumer spending power.

Economic Growth Suffers: Tariffs create inefficiencies by directing demand towards less competitive domestic producers, resulting in wasted resources, lower incomes, and reduced economic growth.

Innovation is Stifled: By shielding domestic firms from foreign competition, tariffs reduce incentives to innovate, adopt advanced technologies, and improve productivity, leading to long-term economic stagnation.

Limited Benefits of a Stronger Dollar: While tariffs can temporarily strengthen the dollar by lowering imports, this effect is minor and short-lived, often harming exporters by making American goods more expensive for foreign buyers.

Retaliation Risks and Trade Wars: Tariffs invite retaliatory measures from trading partners, disrupting trade flows and leaving consumers and exporters vulnerable. Historical lessons from McKinley’s era suggest that reciprocal trade agreements are more beneficial than protectionist policies.

What's actually happening with Trumps tariffs? And why is he wanting to use them?

President Donald Trump's tariff strategy is rooted in his "America First" economic vision, aiming to bolster domestic manufacturing, reduce trade deficits, and generate revenue for tax cuts. By imposing tariffs, particularly on imports from countries like China, Canada, and Mexico, Trump seeks to incentivise companies to relocate production to the United States, thereby creating jobs and enhancing self-reliance. (Source)

A key component of this plan involves using tariff revenues to fund significant tax reductions. The administration estimates that a 10% tariff could generate $350 to $400 billion annually, which would contribute to financing the extension of tax cuts over a decade. To manage this revenue, Trump has proposed establishing the External Revenue Service, a new agency dedicated to tariff collection. (Source)

Trump's approach also includes leveraging tariffs as a tool to address broader policy objectives. For instance, he has announced a 25% tariff on goods from Canada and Mexico, set to commence on February 1, 2025, citing concerns over illegal immigration and drug trafficking as additional motivations for these measures. (Source)

However, this strategy has faced criticism and skepticism. Economists warn that increased tariffs could lead to higher consumer prices, potentially negating the benefits of tax cuts for lower- and middle-income households. There is also concern that such tariffs might disrupt supply chains and invite retaliatory measures from trading partners, which could harm the global economy. (Source)

In summary, Trump's tariff plan is designed to promote domestic economic growth and fund tax initiatives by imposing levies on foreign imports. While intended to strengthen the U.S. economy, the approach carries risks of increased consumer costs and potential trade conflicts.

Will US tariffs impact the UK?

Trump has not announced specific tariffs targeting the United Kingdom. However, his administration's broader tariff policies could indirectly affect the UK economy.

Direct Impact: While there are no direct tariffs on UK goods, the UK's balanced trade relationship with the U.S. may reduce the risk of being targeted by new tariffs. Nevertheless, the UK government has indicated it will "think very carefully" about potential responses if subjected to any new U.S. tariffs. (Source)

Indirect Impact: The UK's economy could face indirect consequences from global trade tensions spurred by U.S. tariff policies. For instance, the National Institute of Economic and Social Research warned that the UK's already slow economic growth rate could be more than halved if Trump's tariffs lead to a global trade downturn. (Source)

Additionally, British companies are expressing concerns about rising labor costs and the potential ripple effects of U.S. tariffs on global supply chains. A survey by the British Chambers of Commerce highlighted that firms are jittery about these developments, which could impact their operations in 2025. (Source)

In summary, while the UK is not currently a direct target of President Trump's tariffs, the broader implications of his trade policies could pose challenges to the UK's economic stability and business environment.

Will inflation in the US impact the UK?

Trade: The U.S. is a major trading partner for the UK. When U.S. inflation rises, the Federal Reserve may increase interest rates to control it. Higher U.S. interest rates can strengthen the U.S. dollar, making UK exports more competitive in the U.S. market due to relatively cheaper prices. Conversely, U.S. inflation can increase the cost of American goods, potentially leading UK consumers and businesses to seek alternatives, thereby affecting trade balances.

Financial Markets: Global financial markets are interconnected. Inflationary pressures in the U.S. can lead to higher yields on U.S. Treasury bonds, attracting investors away from UK government bonds (gilts). This shift can result in higher borrowing costs for the UK government and businesses. For instance, in 2025, concerns over U.S. inflation contributed to a sell-off in UK government debt, pushing the yield on the UK's 10-year gilt to its highest level since 2008. (Source)

Exchange Rates: Inflation differentials between the U.S. and the UK influence exchange rates. If U.S. inflation is higher than in the UK, the U.S. dollar may depreciate against the British pound, making U.S. imports cheaper for UK consumers but potentially harming UK exporters due to less competitive pricing. Historical instances, such as the 1970s, demonstrate how U.S. inflation and monetary policy decisions impacted global exchange rates, including the value of the pound sterling. (Source)

Historical Context: During the 1970s, the U.S. experienced significant inflation, partly due to oil price shocks. This period, known as the "Great Inflation," had global repercussions. The UK's economy was affected through higher global commodity prices and increased costs of imports, contributing to its own inflationary pressures. (Source)

In summary, U.S. inflation can have both direct and indirect effects on the UK economy, influencing trade dynamics, financial market conditions, and exchange rates. The extent of these impacts depends on various factors, including the responses of central banks, investor behavior, and the underlying causes of inflation.