Will tariffs cause inflation? As Democrats and Republicans argue over the effects of tariffs on inflation and the economy, Americans are left to sort it out. Do tariffs cause inflation? Here, we will reveal the factors that cause inflation, examine periods of high inflation in the U.S. since 1800, and see what the facts shows. Politics and facts are often at odds. Numbers tell the story. Now, for the rest of the story.
Inflation: Causes
Inflation occurs when there are too many dollars chasing too few goods. For example, during the recent pandemic, supply chains were disrupted making it difficult to get items like toilet paper and other essentials. At the same time, the federal government was expanding the money supply to ensure the economy didn’t slip into a deep recession. These factors caused an increase in demand and a reduction in supply, which is why inflation reached 9.1% in June 2022. Another cause of inflation is a weak U.S. dollar. This is because a weak dollar makes imports more expensive.
Inflation in the United States: 1800 to 2024
When you consider the annual inflation rate in the U.S. on a calendar year basis back to the year 1800, the U.S. has experienced 30 instances where inflation was 6.0% or higher and 20 occasions with inflation above 8.0%. What caused these elevated inflation rates?
It’s important to understand that prior to 1913, tariffs were the primary source of revenue for the federal government. In 1913, the modern income tax system was created. The first marginal income tax rate (excluding a temporary tax to fund the Civil War) ranged from a low of 1.0% to a high of 7.0%. In 1916, the top rate rose to 15.0%. A year later it was raised to 67.0%. As marginal income tax rates rose, federal revenue increased, and tariffs became less important. In fact, after President Hoover signed the Smooth-Hawley Tariff Act in 1930, tariffs were mostly silent until 2018 and the most recent tariff activity this year.
Inflation – Early 1800s: Beginning in 1800, and using data from the Minneapolis Fed, inflation (on a calendar-year basis) hit 9.1% in 1808. What caused it? A year earlier, President Jefferson signed the Embargo Act of 1807, which restricted trade and disrupted supply. Inflation also hit 13.7% in 1813 and 8.6% in 1814, due to increased government spending to finance the War of 1812 against Great Britain. The war also disrupted trade and reduced supply. In both cases, there were too many dollars chasing too few goods. During the rest of the 1800s, inflation was at or above 6.0% on six separate occasions.
Inflation During WWI: In the early 1900s inflation hit 7.7% (1916), 17.8% (1917), 17.3% (1918), 15.2% (1919), and 15.6% (1920). This extreme and persistent inflation was caused by an increase in government spending which created a surge in demand, while the war caused a disruption in supply. In total, prices rose about 73% from 1916 through 1920.
Inflation – 1970s: Perhaps the worst U.S. inflation occurred in the 1970s. From 1973 through 1982, inflation ranged from 5.7% (1976) to 13.5% (1980). This round of inflation was due to significantly higher oil prices, excess federal spending as the government financed its deficits, and a supply shock. In total, prices rose about 87% during this period.
Who Pays the Tariff?
Will consumers pay the bill? Not necessarily. When tariffs are installed, a part of the tariff may be paid by the exporting government as a subsidy to the exporting company. A part of the tariff may be paid by the exporting company. A part of the tariff may be paid by the importing company. Finally, whatever is left is paid by the consumer.
What Will Consumers Do When Faced with Tariffs?
Consumers have three choices. Some will pay the higher price of the import. Some will buy a lower-priced alternative, if available. Finally, some will not buy it at all, especially if the item is not essential. It’s important to note that if the consumer can find an alternative at a lower price than the import, if it is made in America, that could increase corporate profits of the American company and help boost the economy.
Will Things be Different this time?
Will inflation rise because of the recent tariffs? Possibly. If the federal government sends checks to Americans based on the savings from DOGE, or if the government otherwise expands spending, demand will rise. If tariffs cause a disruption in supply chains, which is a near certainty, supply will fall. Increased demand with decreased supply will result in higher inflation. What makes it difficult to predict is that this time, tariffs are so widespread. One more point. The recent PPI report (Producer Price Index) was quite high. Inflation often occurs at the producer level before it appears at the consumer level (CPI). The August CPI number will be known soon.
Will Tariffs Cause Inflation?
So, will tariffs cause inflation? While tariffs have an inflationary element, it’s not as clear cut as we have been led to believe. Historically, inflation in the U.S. has been caused by an imbalance in the demand-supply data, not because of tariffs. In fact, tariffs are a tax, and taxes are an obstacle to economic growth. Thus, tariffs could have a negative effect on the economy, which may explain why Trump is pushing the Fed to lower interest rates to stimulate economic growth.