Can liberalizing trade reduce US CPI inflation? Insights from an economywide analysis

Tariffs raise the prices of imports in domestic markets. In theory, reducing tariffs should therefore reduce prices. At a time of mounting public concern over US inflation, the empirical question is how much would removal of tariffs imposed in the trade wars of the last five years reduce prices or slow inflation. Prices in the United States have increased over the past two years due to a complex mix of transitory shocks in various markets for goods and services and macroeconomic forces leading to excess aggregate demand. Dealing with the transitory shocks requires policies that focus on commodity markets. In this environment, trade policy, which directly affects commodity prices, can play a role in reducing inflation.

The results of a trade-focused simulation model of the global economy show that if the United States and China eliminated their trade war tariffs and the United States eliminated tariffs on steel and aluminum from all countries and softwood lumber from Canada, consumer price index (CPI) inflation in the United States would decline by 1.3 percentage points from its base level. The price changes would be one-off events, with tariff removal reducing prices only in the year in which they were removed. Inflation is a dynamic process, with aggregate demand exceeding supply over an extended period, causing the rate of change of prices to increase. Although removing tariffs would not address macroeconomic issues related to continuing or accelerating excess demand, it could provide a temporary downward shock to prices that might help dampen inflationary expectations.