US tariffs lower euro area inflation, weaken growth

Import tariffs imposed by the US lower euro area inflation and weaken economic activity over the medium term when trade declines more than expected after tariff increases, according to new analysis by European Central Bank (ECB).

When effective US tariffs on euro area goods rise and exports to the US fall more than historical patterns would suggest, described as “tariff-related trade surprises” (TTSs), euro area inflation declines and activity weakens over time. The results indicate that the effects of reduced demand outweigh inflation-boosting supply-side pressures.

Immediately after a TTS, euro area prices edge up slightly, consistent with higher production costs spreading through supply chains. Over the medium term, however, prices begin to fall. Around one and a half years after a TTS that cuts euro area exports to the US by 1 per cent, the consumer price level is about 0.1 per cent lower.

Industrial production follows a similar pattern, declining over this period before stabilising. The overall pattern resembles an adverse demand shock, ECB said in a blog.

The study identifies TTSs in a two-step approach. First, it estimates expected trade flows using a gravity model covering monthly exports from 20 euro area countries to 192 trading partners during 2002–2019, controlling for structural economic and financial conditions, business cycles and trade agreements. Unexplained variations in euro area exports to the US are classified as trade surprises.

Second, trade surprises are linked to prior changes in US tariffs. When tariffs rose over the previous year and exports were unexpectedly weak, this is treated as a trade-tightening TTS. When tariffs fell and exports were unexpectedly strong, it is considered a trade-easing TTS. The impact of these shocks on prices and activity is then estimated.

The effects differ across sectors. Sectors experiencing larger declines in prices and output in the 12 months after a TTS tend to be more sensitive to monetary policy easing over the same period. Around 60 per cent of the sectors studied, representing roughly 50 per cent of total average euro area industrial output and goods exports to the US, display this pattern.

TTSs push prices and activity down one year after the shock, but easier monetary policy supports them, suggesting that monetary policy can help counter TTS-induced disinflation and cushion the drag from higher trade barriers.

Fibre2Fashion News Desk (HU)