Tariffs, Inflation, and Monetary Policy: Rethinking the Central Bank's Response

Tariffs, Inflation, and Monetary Policy: Rethinking the Central Bank's Response

What happens when a government imposes tariffs on imported goods—not just politically, but economically?

A recent NBER paper by Iván Werning, Guido Lorenzoni, and Veronica Guerrieri reveals a powerful insight: tariffs act as cost-push shocks, akin to labor wedge distortions in closed economies. This reframes how we think about the role of central banks in times of rising protectionism.

Key takeaways:

• Tariffs shift the Phillips curve upward, creating a conflict between price stability and output stabilization.
• Optimal monetary policy should tolerate short-run inflation, smoothing the adjustment to a more distorted long-run equilibrium.
• In the presence of nominal wage rigidities, the cost of disinflation increases—meaning the traditional “see-through” approach to supply shocks may not be ideal.
• Commitment matters: Even under a timeless perspective, the best path involves a temporary inflation overshoot.

This challenges the conventional wisdom and offers an analytical foundation for central banks grappling with the consequences of trade wars and protectionist policies.

Thoughts? Do you think central banks should accommodate tariff-induced inflation shocks or double down on price stability?

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