Tariffs as Stagflationary Shocks in Global Production Networks

A newly developed macroeconomic framework that incorporates global production networks indicates that tariffs function as both demand and supply shocks, leading to ongoing inflation and significant output losses, even if they are temporary. Created by Sebnem Kalemli-Ozcan, Can Soylu, and Muhammed A. Yıldırım, this model takes into account price rigidities, incomplete financial markets, and responses from monetary policy. It highlights how tariff-induced cost distortions ripple through various sectors, resulting in persistent inflation that traditional one-sector models overlook. Additionally, the impact of exchange rates is influenced by wealth transfers through a risk-sharing wedge, which may reverse under conditions of network scarcity. Tariff threats can influence inflation, output, and exchange rates even prior to their enforcement. The study concludes that neglecting input-output connections tends to exaggerate inflation and minimize output costs. Furthermore, monetary policy is intertwined with trade policy, as the rules of foreign central banks can affect domestic results. Even in the absence of retaliation, tariffs can propagate stagflationary pressures worldwide via supply chains and financial mechanisms.