Tariffs and the Fed

The partial government shutdown, poor weather, and the late Easter appeared to dampen the underlying pace of growth in the first quarter. However, April data on retail sales, industrial production, and durable goods orders suggest the softness will be longer lasting. Tariffs distorted activity in 2018, pulling forward imports and adding to inventory growth. However, tariffs were already taking a toll on domestic demand, even before the May 10 escalation. Some fed officials will fear the inflationary implications of higher costs. However, the negative impact on demand should be more of a concern.

The Federal Reserve Bank of New York released a report that indicated last year’s tariffs had an annual cost to the typical household of $419 (or about 0.7% of the median household income). President Trump raised the 10% tariff on $200 billion in Chinese goods to 25% on May 10. The New York Fed estimates that this will impose an additional annual cost to the typical household of $831 (or about 1.3% of the median household income). President Trump has threatened to impose a 25% tariff on the remaining $300 billion or so in remaining imports from China (mostly consumer goods).

Tariffs are paid by the U.S. importer, not China, and are passed along to U.S. consumers and businesses. Tariffs raise costs, invite retaliation, disrupt supply chains, and dampen business investment by increasing uncertainty. Durable goods orders fell sharply in April, reflecting a pullback in aircraft orders (which had spiked in March). However, excluding transportation, orders were flat and March figures were revised lower. Orders for nondefense capital goods ex-aircraft fell 0.9%. Unfilled orders are edging lower. None of this implies that the U.S. economy is in a recession, but growth is slower than it would be otherwise, and signals are flashing yellow.

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Fear of tariffs led to a stockpiling of industrial supplies and materials in the first half of last year, raising pipeline inflationary pressures. However, inflation in prices of raw materials moderated considerably in the second half of 2018, partly reflecting a slowing in the global economy. This latest round of tariffs should put some upward pressure on input costs in the near term, but any impact would be short-lived. The threat to impose tariffs on the remaining imports from China would fall mostly on consumer goods and would hit lower-income households the hardest. Margins are generally low in retail, limiting the ability of firms to reduce the impact. Recent research from the Federal Reserve showed that, while households were generally better off financially in 2018, “many adults are financially vulnerable and would have difficulty handling an emergency expense as small as $400.”