Assessing the Long-Term Inflationary Impact of Tariffs in a Post-Paulson Era

Tariffs have long been a double-edged sword for economies, acting as both a tool for protecting domestic industries and a catalyst for inflationary pressures. In the post-Paulson era, central banks face a complex balancing act: mitigating the inflationary side effects of tariffs while addressing their recessionary risks. This analysis explores how evolving monetary policy frameworks-from the "look through" approach of the Paulson era to modern expansionary strategies-shape the long-term inflationary trajectory of trade policies.

The Paulson Era: "Look Through" and Anchored Expectations

During the Paulson era at the Federal Reserve, policymakers adopted a "look through" stance toward tariff-driven inflation, treating such shocks as temporary and unlikely to disrupt long-term price stability. Philadelphia Fed President Anna Paulson emphasized, in a Minneapolis Fed analysis, that tariffs, while raising import prices, would not leave a "lasting imprint on inflation" due to anchored expectations and limited pass-through to consumer prices. This approach mirrored historical central banking practices, where nominal anchors like money supply targeting or exchange rate fixings prioritized long-term stability over short-term volatility, as argued in an FRBSF Economic Letter.

For example, an Atlas Investment analysis, citing estimates from the Federal Reserve Bank of Boston, suggested that a 10% tariff on all imports could increase core goods PCE prices by 0.3%, with broader implications for core PCE inflation. However, Paulson's strategy relied on the assumption that labor markets would cool and firms would absorb costs rather than pass them to consumers. This proved effective in the short term, as core PCE inflation moderated to 2.6% by March 2025, its lowest level since 2021, according to BEA core PCE data.

Modern Central Bank Responses: Expansionary Policy and Trade-Offs

In contrast to the Paulson era, recent studies advocate for a more proactive, expansionary response to tariffs. A New Keynesian model enriched with global value chains suggests that central banks should tolerate higher inflation to counteract the recessionary forces of tariffs, such as reduced consumption and employment. This approach is supported by empirical evidence from the same study: a 25% tariff on Canadian and Mexican imports could add 0.8 percentage points to core inflation, while a 60% tariff on China could push it up by 2.2 points.

The Federal Reserve's 2025 policy directives reflect this shift. Despite core PCE inflation rising to 2.9% in August 2025, the Fed maintained a target federal funds rate of 4.25–4.5%, prioritizing employment stability over aggressive rate hikes, according to an Oanda analysis. This mirrors the Minneapolis Fed's recommendation that expansionary policy helps realign relative prices between producer and consumer inflation, mitigating demand inefficiencies caused by tariffs.

Long-Term Inflationary Dynamics: Data and Policy Implications

Longitudinal data from 2020 to 2025 reveals a nuanced picture. While tariffs initially caused sharp spikes in producer prices (PPI), their pass-through to consumer prices (CPI) has been uneven. For instance, a 25% tariff on investment goods led to a 9.5% price increase compared to 2.2% for consumption goods, due to higher import content in investment sectors, as discussed in the FRBSF Economic Letter. However, these first-round effects have not translated into sustained inflation, as central banks adjusted policies to stabilize expectations.

Central banks globally have also recalibrated their strategies. The European Central Bank and Bank of Canada paused rate cuts in 2025 to assess tariff risks, while the Bank of Japan delayed hikes amid export-dependent vulnerabilities, as highlighted in the Oanda analysis. Meanwhile, the U.S. Fed's "wait-and-see" approach has allowed markets to price in gradual rate cuts by late 2026, reflecting confidence in inflation's eventual moderation, per the same Oanda commentary.

Investment Implications and the Road Ahead

For investors, the post-Paulson era underscores the importance of hedging against sector-specific inflation risks. Tariffs disproportionately affect industries reliant on global supply chains, such as manufacturing and technology, while services inflation remains resilient, according to BEA core PCE data. Central banks' focus on employment stability suggests that accommodative policies may persist longer than in previous inflationary cycles, favoring equities over fixed income.

However, the long-term outlook hinges on whether tariffs trigger a self-reinforcing inflationary spiral. Historical precedents, such as the Smoot-Hawley Tariff of 1930, caution against unchecked protectionism, which can provoke retaliatory measures and collapse trade flows, as noted in the Atlas Investment analysis. Modern central banks, armed with flexible inflation targeting frameworks, appear better positioned to navigate these risks-but not without trade-offs.

Conclusion

The interplay between tariffs and central bank policy in the post-Paulson era reveals a dynamic landscape. While historical "look through" strategies provided short-term stability, modern expansionary approaches aim to balance inflation control with economic resilience. For investors, understanding these policy nuances-and their sectoral impacts-is critical to navigating a world where trade policy and monetary action are inextricably linked.