The cost of living crisis, which saw inflation in the US peak at a four-decade high of 9.1% in 2022, played a significant role in determining the outcome of last November's presidential election.
Author
- Conor O'Kane
Senior Lecturer in Economics, Bournemouth University
Exit polls across ten of the key battleground states showed 32% of voters considered the economy to be the most important election issue. Among that group of voters, a staggering 81% voted for Donald Trump.
Trump had spent most of his election campaign saying his administration would tackle high prices - even vowing to bring them down on day one . However, the latest figures suggest inflation in the US has increased since he took office, rising unexpectedly to a six-month high of 3% in January.
This rise is largely because of the economy Trump inherited. But some experts have expressed concerns that his stated economic strategy, including trade tariffs, major tax cuts and lower interest rates, will only add to inflation.
While tax cuts and interest rate changes are familiar policies, the use of tariffs has been less common in recent decades. These are used by governments to balance trade relationships or in retaliation to tariffs imposed by other countries. They generally make foreign imported goods more expensive while also raising tax revenues for governments.
The Trump administration has set tariffs of 25% on all steel and aluminium imports , and imposed 10% trade tariffs on a wide range of consumer imports from China. While proposed tariffs of 25% on imports from Mexico and Canada have been temporarily paused , the US has signalled its intention to introduce tariffs on imports from the European Union.
Will tariffs lead to inflation?
Trump's aides insist the tariffs won't have a negative impact on American consumers and businesses. On February 18, Peter Navarro, senior counsel for trade and manufacturing at the White House, told the New York Times : "It's not going to be painful for America. It's going to be a beautiful thing."
Navarro argues that foreign exporters, concerned about losing market share, will reduce the pre-tariff price they charge US importers.
But economic theory suggests that tariffs generally do lead to higher prices. Peter Lavelle, a trade expert at the UK's Institute for Fiscal Studies, says that evidence from Trump's first term - when tariffs were imposed on solar panels, washing machines, steel and aluminium - shows these costs were "almost entirely passed on to domestic consumers", thus adding to inflation.
A key reason for the tariffs is to make US domestic manufacturing more competitive on the international stage. This could bring manufacturing jobs back to the US. Manufacturing employment declined by 35% in the US from its peak of 19.6 million in 1979 to 12.8 million in 2020.
However, there was no evidence of tariffs bringing manufacturing jobs back to the US during Trump's first term. In fact, manufacturing employment remained static between 2017 and 2021.
There are fears that tariffs could instead trigger a trade war, where countries retaliate with tariffs of their own. Canadian officials, for instance, have made it clear they will introduce retaliatory tariffs on the US - "selected in order to hit particularly red and purple [Trump-supporting] states".
Economists analyse such scenarios using game theory. A trade war takes the form of what economics-speak calls a "non-cooperating Nash equilibrium", where the economic outcome is negative for all countries involved.
Some recent modelling on the impact of Trump's proposed tariffs on Canada and Mexico supports this view . Tariff retaliation is likely to raise inflation rates even further than otherwise in all three economies.
A trade war could also squeeze profit margins for exporting producers in the US, by making some US-produced goods relatively more expensive. This would show up in lower real income through reduced employment and wages. This outcome, like higher prices, is unlikely to be popular with US voters.
Given the evidence from Trump's first term, it is difficult to see how tariffs will be anything but inflationary. Trump's proposed tax cuts valued at US$5-11 trillion would also add to inflationary pressures, as would the lower interest rates he has called for.
Ana Swanson, a trade and international economist at the New York Times, believes the threat of tariffs is being used merely as a negotiating strategy. However, like many other economists, Swanson sees uncertainty as the biggest impact of Trump's tariff policy.
In a podcast on February 4, she said: "If you, as the business, are watching out for the threat of tariffs, are you going to make an investment in a new factory or hire new workers?" Uncertainty leads to reduced investment and lower growth.
Realistically, Trump was never going to bring down prices for US consumers. To do that would be deflationary, and economists generally fear deflation even more than inflation. Falling prices lead to deferred spending and can be devastating for economic growth.
The best outcome for US consumers is that prices increase at a slower rate, close to the US Federal Reserve's inflation target of 2%. However, given the recent uptick in inflation, as well as Trump's strategy of tariffs, tax cuts and lower interest rates, the direction of travel all points towards higher price rises.
Recent evidence from elections in many advanced economies shows that voters do not like inflation, and will punish administrations who are in power during inflationary periods.
Since inflation peaked in many advanced economies in 2022, more than 70% of incumbent administrations have been voted out of government. Trump should keep this in mind as he embarks on his quest to make America's economy great again.
Conor O'Kane does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.
