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This edition was written by Emily Araujo, Alex Conner, Chase Parry, Jack Spira, and David Wessel.
The conventional view is that increases in tariffs are passed through to prices and therefore cause a temporary increase in inflation. Stephanie Schmitt-Grohé and Martín Uribe of Columbia University find that the macroeconomic effects of tariffs depend on their persistence. Short-term tariffs temporarily reduce imports and improve trade balances without causing a measurable rise in inflation or an economic contraction. Permanent tariff hikes, by contrast, result in a temporary rise in inflation without shifting long-run trade balances. The authors also find that tariff shocks have not been important drivers of U.S. business cycles, even during periods such as Nixon 1971, Ford 1975, and Trump 2018 when tariffs increased substantially.
Growth rates in U.S. house prices demonstrate high persistence; that is, high (low) growth in one period is often followed by high (low) growth in the next. Analyzing four decades of house price growth across 279 metropolitan statistical areas, Chi-Young Choi and Aaron Smallwood of the University of Texas and Alexander Chudik of the Federal Reserve Bank of Dallas show that this persistence has varied over time, increasing significantly in the mid-1990s and stabilizing at a higher level in the early 2000s, before the housing boom/bust of that decade. Much of this increase in average national persistence was driven by the South and Midwest, which previously exhibited lower levels of persistence than other regions. The authors find that expansion in the credit supply (as proxied by growth in bank deposits) explains the variation in persistence—both over time and across areas—better than buyer expectations (proxied by past growth in house prices), even in areas with greater supply-side constraints.
OECD estimates show that profit shifting—a strategy whereby large multinationals reduce their tax burden by recording profits in low-tax jurisdictions instead of high-tax jurisdictions—costs governments $100 to $240 billion in lost tax revenue annually. Fotis Delis and co-authors from the European Central Bank construct a global database of profit shifting estimates from 2009 to 2020 for more than 500,000 firms. They find that the 20 largest profit-shifting multinationals are concentrated in the information technology, pharmaceutical, and petroleum industries and that most of their profit shifting takes place between high-tax countries like the U.S. and France and low-tax jurisdictions like Ireland and the Cayman Islands. They show that global profit shifting increased from $300 billion in 2009 to $700 billion in 2017. The average share of profits shifted dropped from about 20% in the early 2010s to about 10% later in the decade, coinciding with European Union enforcement actions and the introduction of minimum tax provisions in the Tax Cuts and Jobs Act in 2017.
“What should our reaction function be, if we know that the road ahead is likely to be more uncertainty?... The recent inflation surge has revealed upside non-linearities–and with them, the need for a two-sided reaction function, both in terms of forcefulness or persistence. This is not about reacting to small or temporary deviations, but about a symmetric commitment to respond to inflation dynamics that could de-anchor inflation expectations in either direction," says Christine Lagarde, President of the European Central Bank.
"When disinflationary shocks risk pushing policy rates towards the lower bound, acting forcefully early on helps minimise the time spent near that constraint. Likewise, when inflation overshoots raise the risk of a feedback loop between frequent price adjustments and staggered wage responses, forceful tightening at the outset is key to anchoring expectations.
We began our recent policy cycle with historically large rate hikes delivered at an unprecedented pace. Our analysis shows that, had we not acted, the probability of inflation expectations de-anchoring would have exceeded 30% in 2022 and 2023.”
