How Do Tariffs Impact The Economy?
Macro Mechanics
The best information we can ever provide investors is the mechanics of how we think about macro conditions over time rather than what we think about them at any particular time.
Consistent with this idea, we present our Macro Mechanics, a series of notes that describe our mechanical understanding of how the economy and markets work. These mechanics form the principles that guide the construction of our systematic investment strategies. We hope sharing these provides a deeper understanding of our approach and ongoing macro conditions.
Thus far in our Macro Mechanics series, we have provided our understanding of the following subjects:
We highly recommend reading these previous notes if you are unfamiliar with our approach. Today, we turn to a subject that many macro-market investors are concerned about: tariffs.
Since the U.S. presidential election replaced the previous administration, tariffs have become a primary focus for markets, with incremental news flow driving price action. The durability of price trends will depend on whether economic data comply with price moves to create a robust macro trend. To that end, we offer our understanding of how tariffs may impact the economic picture.
We expect tariffs to have a minimal impact on nominal GDP conditions, a marginally higher impact on profits, and a potentially moderate impact on inflation. We dive into the mechanics of these outcomes. Before we look at the specifics of each prospective impact, we want to begin with a high-level conceptual description of how tariffs flow through the economy.
A tariff is a tax imposed by a government on imported goods and services to make imports less attractive than domestic production. The objective of tariffs is to improve the trade balance in favor of the domestic economy, either by increasing domestic business profits or by reducing the government deficit. As such, tariffs operate by changing the composition of nominal spending rather than directly impacting the total amount of nominal spending. This dampens the direct effects of tariffs on nominal GDP and biases their effects toward profits and inflation. We explain each channel.