The Hutchins Roundup brings the latest thinking in fiscal and monetary policy to your inbox. Have something you'd like us to include in the next Roundup? Email us and we'll take a look.
This edition was written by Tristan Loa, Georgia Nabors, Jack Spira, and Louise Sheiner.
In 1994, the North American Free Trade Agreement (NAFTA) between the U.S., Mexico, and Canada introduced reciprocal tariff reductions, lowering taxes on imports and exports for the three countries. Using product-producer level data distinguishing between Mexican goods sold abroad and those sold domestically, Felipe Brugués of the Autonomous Technological Institute of Mexico and co-authors find that tariff reductions lowered the price of Mexican domestic goods by approximately 11% on average. First, the reduction in tariffs levied by the Mexican government on foreign goods increased competition for Mexican firms and reduced domestic prices. Second, lower tariffs on inputs reduced marginal costs for Mexican producers but also allowed them to expand their profits through higher markups. The net impact of lower input tariffs was a small decline in domestic prices – the effect of lower production costs partially offset by higher markups. They find that lower input tariffs had a similar effect on Mexican export prices: firms increased markups, thereby raising export prices, but this effect was dominated by price reductions from lower marginal production costs.
Testing the argument that recent inflation shows the Phillips curve to be nonlinear—that is, that inflation increases more sharply at higher levels of employment—Paul Beaudry of the University of British Columbia, Chenyu Hou of Simon Fraser University, and Franck Portier of University College London demonstrate that this holds only under certain methodological choices. They find that when comparing inflation and employment across cities, thereby controlling for the effect of common shocks and expectations, the Phillips curve instead appears quite flat, with little variation in inflation despite large changes in employment. Looking at geographically aggregated data and controlling explicitly for different measures of expected inflation, they obtain a nonlinear Phillips curve only when using the inflation expectations of professional forecasters; under the expectations of households and businesses, however, the curve remains quite flat. The results cast doubt on the existence of a strong causal link between employment and inflation (which could just as well be driven by supply shocks or price expectations) and accordingly caution against monetary policy that is overly focused on changes in employment.
Did the trade war between the U.S. and China in 2018 and 2019 increase U.S. inflation? Pablo Cuba-Borda of the Federal Reserve Board and co-authors find that U.S. tariffs on Chinese imports and China’s retaliation did drive up U.S. prices. The tariffs led to a one-time increase in the price of final goods, such as washing machines, without a persistent increase in the inflation rate. But tariffs on intermediate goods, such as batteries or boat motors, have a more persistent increase in inflation. As the cost of importing intermediate goods rose, U.S. firms bought from other sources (including domestic sources), but those aren’t perfect substitutes. The result is a persistent increase in U.S. production costs and decreased efficiency, which leads to higher inflation rates for some time. The associated increase in Fed interest rates then leads to a persistent drag on U.S. GDP growth.
“Based on analysis, tariffs, on consumer goods especially, feed into import prices pretty strongly, that does filter into prices that consumers pay. That happens relatively soon. Tariffs that feed into intermediate goods... tend to pass through more gradually and last a little bit longer in terms of their effects. My view is, based on what we know today, given all the uncertainties around that, I do factor in some effects from tariffs now on inflation, on prices, because I think we will see some of those effects later this year... You also have to factor in how that affects economic activity, decisions by businesses to invest, consumers to spend, and that’s where I think another big uncertainty is," says John Williams, President of the Federal Reserve Bank of New York.
"The conditions back then were where inflation had underrun our target moderately for about a decade... We were in a very good economy. The actual policy actions that happened clearly affected the economy. We saw some short term boost in inflation, but it was in the context of an economy that hadn’t seen inflation in a long time. In the context of the past few years, the businesses have become much more attuned on how to pass through cost increases. They feel they have more pricing power. They’ve flexed that pricing power during times of shortage. And households are also very sensitive to prices and high costs of many goods. It is a very different situation today than in 2018. It's a different context.”
Call for papers
We are seeking papers on the municipal bond market, state and local fiscal issues, taxes, infrastructure spending, and climate change for the Municipal Finance Conference to be held in-person Tuesday, July 22, 2025 and Wednesday, July 23, 2025 in Washington, D.C.
New paper alert
Louise Sheiner, Wendy Edelberg, and Ben Harris of Brookings assess the likelihood that the federal debt will lead to a crisis. Read it here.
About the Hutchins Center on Fiscal and Monetary Policy at Brookings
