Cost Squeeze Limits Inflation Impact of Tariffs – for Now

It is generally understood that Gross Domestic Product (GDP) does not include the value of imports. It is, however, less well appreciated that in the System of National Accounts tariffs are treated as domestic value added. That is, customs duties are included in GDP.

From the first to the second quarter of this year customs duties surged $170.7 billion, from $97 billion at an annual rate to $267.7 billion -- an annualized growth rate of 5700%! -- as new tariffs imposed by the Trump Administration took effect. All else equal, if that increase in tariffs had immediately passed through to prices faced by final demanders of domestic product, the annualized rate of change in the GDP price index would have spiked nearly 3 percentage points in the second quarter. As it happened, GDP inflation in the second quarter was tame at 2.1%. Obviously, there were tariff slips twixt cup and lip.

The Bureau of Economic Analysis, in Table 1.1.8 of the National Income and Product Accounts (NIPA), routinely reports contributions to GDP inflation made by changes in elemental prices. However, to understand better why inflation remained quiescent in the second quarter despite the huge increase in tariffs, I used data on the income side of the NIPA to decompose inflation into contributions made by unit costs based on detail shown in table 1.10 of the NIPA, “Gross Domestic Income (GDI) by Type of Income.”

Keep in mind that if all components of nominal GDI grow at the same rate, the contributions of unit costs to inflation are approximately equal to the inflation rate times the shares of each cost in GDI. For example, the “normal” contribution of unit labor costs to inflation of 2.1% is approximately 0.67 x 2.1% = 1.4 percentage points.

Turning to the results of my decomposition shown in the nearby chart. The contribution from customs duties per unit of real GDP was a stunning 2.2 percentage points in the second quarter, more than accounting for the entire increase in the GDP price index. However, that outsized contribution was offset by an undersized contribution from unit labor costs and outright declines in unit rental income of persons, unit proprietors’ income, and unit corporate profits. This strongly suggests the cost of recent new tariffs is being squeezed from other costs and from net incomes – at least for now.

A PDF version of this commentary with Technical Appendix is available here.