Tariffs: A Threat to US Consumer Spending Power?

As the US administration considers sweeping tariffs on imports, consumers are left wondering how these measures will impact their spending power. With many important elements still unknown, it's clear that these policies could have significant consequences for the Canadian and US economies. In this article, we'll explore the potential impacts of tariffs on consumer spending and inflation expectations in the United States.



The Impact on Consumer Prices

Tariffs are taxes on imports that increase the price consumers and businesses pay for goods and services. When the US imposes tariffs on goods from Canada, Mexico, and China, the prices of essential consumer goods in the US are likely to increase. This is because tariffs make foreign goods more expensive, leading to higher prices for consumers. Some of the sectors most affected by these tariffs include electronics, automobiles, fuel, food, and steel.

For instance, the US imports a significant amount of electronics and consumer goods from China. A 10% tariff on Chinese imports could lead to higher prices for these products. Similarly, the US car industry is a complex mix of foreign and domestic manufacturers, with supply chains crossing borders multiple times. If tariffs are imposed on these goods, the parts would be taxed each time they move countries, leading to an even bigger increase in prices. Additionally, Canada provides around 60% of US crude oil imports, and Mexico roughly 10%. If tariffs are imposed on these goods, the US could see an increase in fuel prices of up to 50 cents (40p) a gallon, according to economists.

Retaliatory Measures and Supply Chain Disruptions

Affected countries, including Canada, are expected to impose retaliatory tariffs on their imports of goods from the United States. This could lead to a significant substitution away from US exports, further disrupting US supply chains and consumer spending. For example, Canada could impose tariffs on US goods, making them more expensive for Canadian consumers and businesses, which would likely lead to a substitution away from US goods.

Tariffs on intermediate goods can amplify the impacts of tariffs on production costs and prices. For instance, in the process of making a car, parts and components of motor vehicles cross the Canada-US border several times. If these components are taxed each time, it would amplify the increase in production costs and increase the prices paid by consumers on both sides of the border. This could disrupt US supply chains, particularly in industries with highly integrated international supply chains, such as the motor vehicle sector.

Inflation Expectations and Consumer Spending

The pass-through of tariffs to prices for final goods is initially low but increases gradually over time. This is due to businesses absorbing part of the increase in costs initially, but as time passes, they are less able to do so and pass on the costs to consumers. This gradual increase in prices for final goods can lead to higher consumer price index (CPI) inflation over time.

The implications for US consumer inflation expectations are that they may become less well anchored to the inflation target. When expectations are well anchored, tariff-related price increases have less of an effect on other prices and wages. However, as the pass-through of tariffs to prices for final goods increases over time, consumers may start to expect higher inflation, leading to a self-reinforcing cycle of higher inflation expectations and actual inflation.

This can be seen in the example of the US-China trade war, where the increases in US tariffs on Chinese products between 2018 and 2019 led to an average price index increase of 1.09%, with a disproportionately larger impact on low-income households. This suggests that tariffs can have a significant impact on consumer prices and inflation expectations, particularly for lower-income households who may be more sensitive to price increases.

In the hypothetical scenario provided by the Bank of Canada, a permanent tariff of 25% on all goods imported by the United States, including from Canada, would lead to a one-time, permanent increase in price levels. Whether tariffs lead to ongoing inflation would depend on how household and business expectations for inflation respond to tariff-related price level increases. If expectations are not well anchored to the inflation target, tariff-related price increases could have a more significant and lasting impact on inflation.

Conclusion

In conclusion, the proposed tariffs on goods from Canada, Mexico, and China will likely impact the prices of essential consumer goods in the US, with certain sectors being more affected than others. Retaliatory measures by affected countries could further disrupt US supply chains and consumer spending, leading to lower GDP growth and higher inflation. The pass-through of tariffs to prices for final goods is expected to increase gradually over time, leading to higher consumer price index (CPI) inflation. This can have implications for US consumer inflation expectations, particularly if expectations become less well anchored to the inflation target. The example of the US-China trade war and the hypothetical scenario provided by the Bank of Canada illustrate the potential impact of tariffs on consumer prices and inflation expectations.