economy

Tariffs: Tariff-ic or Tarri-ble?

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In 2025, the U.S. government announced a variety of tariffs on goods imported into the U.S. from other countries. The way tariffs work is that when goods are imported into the country, the company importing them pays a percentage of the cost of the goods to the government. So, a tariff is just another type of tax. An imported good that costs $1000 with a 30 percent tariff rate causes the importing company to pay $1000 to the foreign company for the product, plus $300 to the U.S. government. Will the new price of the good to the consumer be $1300? Or will the importer or producer eat some of the tariff, reducing their profit margin? That is a complicated question, as we will see. But let’s first look at the benefits of international trade and why it occurs.

Economists generally think international trade makes everyone better off because of a concept called comparative advantage. The idea is that your own country is relatively better at producing certain goods and services, and other countries are relatively better at producing other goods and services. These days, U.S. firms have a comparative advantage in tech, banking, and accounting. Other countries have a comparative advantage in producing goods—China and other countries for producing clothes and toys, Europe for producing wine and chocolate, Japan for producing steel and autos, and so on. So, it makes sense for each area of the world to produce the goods they are best at producing, and to trade with others. When tariffs are imposed by a country, the tariffs change the prices to consumers, distorting their decisions, and reducing the benefits brought by trade.

Will anyone benefit from tariffs? The main benefits of tariffs go to the domestic workers and firms in the industry that is subject to the tariff, plus the U.S. government, which gains tariff revenue. When foreign goods become more expensive, domestic firms’ sales can go up, or they can raise their prices, or both. Sometimes, tariffs imposed worldwide on a product can lead to new production within the country that imposed the tariff, which is what happened with washing machines in 2018 when firms started producing more washing machines in the U.S.

Who bears the cost of tariffs? In the first five months of 2025, U.S. tariffs brought in over $60 billion to the U.S. government, which is roughly 0.6% of GDP (about $10 trillion) over that same period. Economists have tried to see how tariffs affect prices and profits, and doing so is complex. First, the net price to consumers (or businesses, in the case of tariffs on goods used in production) may be higher, so they buy less of the good with the tariffs. They substitute to other goods, perhaps those without tariffs, and they just spend less because of the higher price as their purchasing power shrinks. Second, the reduced demand for the product affects the suppliers. They might decide to reduce prices because of the lower demand for their product, so their profit margins decline. Similarly for the importing company. Thus, the cost of the tariff will be borne by demanders, suppliers, and import firms (as well as retailers, and everyone else involved in the supply chain). However, if a tariff on a product is imposed on just one country (China, for example), production may simply shift to another country (such as Vietnam).

Do the benefits to a country from imposing tariffs exceed the costs? Or do the costs exceed the benefits? In theory, if a government has a lot of information on supply and demand and how both respond to tariffs, it could find the optimal tariff that would benefit the country, though at the expense of people in other countries, and the costs to those people exceeds the benefits to the country that imposed the tariff.

Then, there’s the issue of retaliation. When the U.S. imposes tariffs on products imported from other countries, those countries might retaliate and impose tariffs on goods and services that they import from the U.S. In that case, everyone is worse off, and the gains from comparative advantage are lost. Despite the worldwide decline in tariffs over the past 80 years, both the U.S. and other countries still protect certain products from foreign competition. The U.S. has high tariffs on pickup trucks from other countries to protect large U.S. automakers from foreign competition. The tariff on pickup trucks was originally a retaliation by the U.S. for a tariff that Germany placed on imported chicken, pricing U.S. chicken out of their market.

As it turns out, many economists and politicians have judged the benefits of tariff reductions to exceed the costs. That is why the U.S. government has been the world’s leader in reducing tariffs all over the world from the 1940s to the 2010s, under the principle of reciprocity—we reduce our tariffs on their goods if they reduce their tariffs on our goods. That led U.S. tariffs on imported goods to decline from about 15 percent on average 100 years ago to about 1.5 percent in 2024, with a similar decline on foreign tariffs on U.S. goods.

The most complex issue with tariffs is their impact on the overall balance of trade. The U.S. has a huge trade deficit with the rest of the world. We import much more than we export, with an average trade deficit of 3 percent of our GDP over the past decade. Countries that sell many goods to the U.S. spend the funds they earn to buy U.S. financial assets. The danger from higher U.S. tariffs is that it may reduce foreigners’ willingness and ability to buy our bonds, especially U.S. government bonds, making it more expensive to finance our huge U.S. government budget deficit. Of course, that could also affect the value of the dollar against other currencies, leading to even further impacts on trade between countries.

Do tariffs help create domestic jobs? The answer is yes, but at a high cost to consumers. A great example is the case of washing machines in 2018. The U.S. imposed a tariff on imported washing machines, and U.S. prices for washing machines rose by about the amount of the tariff, roughly $90; and since dryers are a complementary good, their prices went up by about the same amount. Most importantly, Samsung, LG, and Whirlpool increased their production in the U.S., so the goal of the tariff seemed to be achieved. With 1,800 new jobs created, the policy was a success. But the price was high. The U.S. government received $82 million annually in additional tariff revenue and consumers paid $1.5 billion in higher prices. That’s a net cost to the economy of $815,000 per job created per year.

The case against tariffs might seem clear cut, but there is one major issue that is unresolved in support of tariffs and against free trade. Because of comparative advantage, many companies in industries like steel and textiles have shut down plants in the U.S. and relocated to other countries. Labor is cheaper there (even though foreign workers are not as productive as U.S. workers), so they start producing their products in other countries like China or Vietnam. But what about the U.S. workers left behind? Shouldn’t we care about them? The answer is: yes, we should. In fact, it is explicit in U.S. law that the government can provide assistance to communities left behind. So, when manufacturers abandoned cities in the U.S. Midwest, and they became centers of the opioid crisis in the U.S., the government should have come in and provided training and jobs to those displaced workers. But the government failed those workers completely and left them to suffer on their own. Targeted programs to help displaced workers are needed as a complement to free trade, to prevent societal disruptions.

In summary, tariffs are a complicated subject. The bottom line is that historically, the U.S. government has been a champion of lower tariffs across countries on a reciprocal basis. Lower tariffs are economically efficient and make consumers all over the world better off. Higher tariffs on particular products help certain workers and firms at the expense of others. A better solution to help displaced workers is for the government to help them out directly, rather than using tariffs, which distort economic decisions.

Data Watch: Why Do Economic Data Get Revised?

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Data on the economy are not precise and get revised over time. Why? The early estimates of economic data like GDP are initially released based on partial information. We only get more complete information later—sometimes much later.

Government statisticians face a tradeoff between timeliness and accuracy. If the government wants to release only GDP numbers that are very accurate, it would have to wait for a long time before releasing any data at all. For example, a fairly accurate measure of GDP for 2024 will be released by the government statistical agency (the Bureau of Economic Analysis, BEA) at the end of September 2025. That’s a long time to wait to get a comprehensive measure of how much output was produced by the U.S. economy. Instead, we got a first estimate of GDP for 2024 in January 2025, and it was revised in February and again in March. But more complete source data are available by the end of September, and the number for 2024 that will be released then will be much more accurate. For that reason, it is crucial that policymakers understand the process of producing the data.

Recently, some policymakers have focused on the revisions to the employment data for May and June 2025, and wondered if they might have been manipulated for political purposes. But the data on employment are routinely revised, sometimes by a significant amount. We need to remember that those data are monthly, and the size of the data revisions was puny, because monthly movements in the data are small. The revisions in question were less than 0.1 percent of the total number of people employed. However, it is true that the revisions were relatively large, compared with other revisions to the number of people employed at firms. Only 4 percent of all revisions from the first release to the second release since 1964 were larger in magnitude than the revision of the June value. Only 7 percent of all revisions from the first release to the third release since 1964 were larger in magnitude than the revision of the May value.

But I wonder why people focus so much on monthly data in the first place. Monthly data are very noisy—our measurement is not precise and many random things happen in a month. It would be preferable to look at quarterly data or even annual data. When you average a data measure over longer periods, you smooth out the noise and get a more precise measure. With quarterly averages, 15 percent of all revisions from the first release to the third release were larger than that in the second quarter of 2025; while 17 percent of all revisions from the first release to the second release were larger than that of the second quarter of 2025.

So, our analysis of past revisions going back to 1964 suggests that the revisions that just happened to the employment numbers were larger than normal, but far from the largest, and many revisions in the past have been even larger.

Even more importantly, the fact is that government data agencies follow strict rules for how they conduct their work. They follow well-established procedures for how to deal with the raw source data they get and then generate from those incomplete numbers the overall values of the data series being produced. If you look at when the largest revisions to GDP and employment have occurred in the past, you see that unusual events led to large revisions. The largest revisions to the GDP data occurred in the stagflation of the 1970s, the 9/11 attacks, the financial crisis in 2008, and the pandemic in 2020. Large employment revisions occurred in similar time frames. It is possible, and worth further exploration, that the cuts to government employment in 2025 by DOGE were not counted well by the BLS. If so, perhaps some modification of BLS procedures could be in order. But it is difficult for a government statistical agency to anticipate that type of shock, and modify its procedures to account for it, before it happens. In my studies of data revisions over the past 25 years, I have learned a lot about the data production process. The key thing to remember is that if data were not revised, the data would just be wrong forever. Data revisions improve the precision of the data. We are fortunate that U.S. data are among the best in the world, and always getting better, especially after they are revised.

Data Watch: Introduction to Inflation

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Prices of the goods we buy seem to be getting higher and higher every year. Inflation is caused when the central bank (the Federal Reserve in the United States) allows the amount of money in circulation to grow too fast, or equivalently, if the central bank sets interest rates too low. Inflation causes the value of your money to decline, so you bear a direct cost.

What Does a Dollar Buy Today?

When inflation occurs, prices of goods rise, on average. So, a dollar buys less than it used to buy. How much is a dollar worth today, compared to the past?

As the table suggests, a dollar buys nowhere near what it used to. It now takes $8 to buy what $1 bought in 1962.

To get an idea of how much prices have changed in a year, we can calculate the inflation rate as the percentage increase in prices from one year earlier. The graph below shows the results of this calculation from 1960 to 2025.

In the chart, you can see that inflation in the early 1960s was very low. But inflation began to rise steadily in the late 1960s and into the early 1970s. Then, from 1974 to 1975, inflation jumped to double-digit levels. Inflation dropped for a short time later in the 1970s, but jumped up again in 1979 and 1980. Inflation began to decline in the early 1980s, rose a bit in the late 1980s, and then declined to below 2 percent in the 1990s. The 2000s saw volatility in inflation, though on average inflation remained fairly low. The inflation rate was negative for a short time in 2009, mainly because of a sharp decline in prices during the financial crisis. In the 2010s, the inflation rate remained below 2 percent, which is sometimes thought to be the optimal rate of inflation. But in March 2021, inflation jumped up sharply, as the effects of the pandemic subsided. Today, the inflation rate is about 2.5 percent.

What Causes Inflation?

In the short run, inflation can rise or fall from a number of factors, especially from temporary increases in food or energy prices. But in the long run, it turns out that only an economy’s central bank determines the inflation rate.

Historically, most of the periods in which a country has allowed inflation to reach high levels, as in the United States in the 1970s and early 1980s, were periods in which the central bank of the country allowed the amount of money in circulation to grow at a faster pace than it should have. The central bank is the entity that is in charge of distributing money in a country; in the United States, the central bank is the Federal Reserve, called the Fed for short. In the 1970s and early 1980s, the Fed made severe errors in judgment. The Fed’s leaders thought that the Fed should increase the money supply at a faster pace because the economy was growing slowly. But the increase in the money supply caused high inflation and did not help the economy grow faster at all.

Here is a plot of the relationship between the growth rate of the money supply and the inflation rate from 1960 to 1979. As you can see, increases in money growth were followed by higher inflation rates about two years later. Decreases in money growth were followed by decreases in inflation about two years later. This illustrates one of the difficulties the Fed faces in setting monetary policy—it doesn’t know if its policy was right or wrong until two years have passed. Then, if it has made a mistake, it takes another two years to correct it.

Another difficulty the Fed faces in setting monetary policy is that innovations in the banking sector cause the demand for money to change and this disrupts the relationship between the growth rate of the money supply and the inflation rate. In the graph above, which showed data from 1960 to 1979, you can see that as the money growth rate changes, the inflation rate responds with a lag of about two years. But the relationship changed after 1980 because of technological improvements in the banking system, which led the Fed to abandon the attention it paid to the money supply. Essentially, after 1980, U.S. money demand became so erratic that the Fed could no longer judge the appropriate size of the money supply necessary to control inflation. So, it gradually switched to a different method, which was to judge the appropriate level of the interest rate in the economy. Instead of money demand driving inflation, the idea is that the nominal interest rate on short-term securities needs to be at the right level. If the interest rate is too high, then inflation will decline; if the interest rate is too low, then inflation will rise. However, the difficulty in this approach is figuring out what the appropriate level of the interest rate is when conditions in the market are changing.

Today, inflation is about 2.5 percent. The Fed targets it at 2 percent, so inflation remains higher than desirable. It is the Fed’s duty to reduce it to 2 percent over the next few years. Given how the Fed operates, the current inflation rate calls for the Fed to increase interest rates slightly now, to bring inflation down to a lower level.