One redistributes buying power; the other limits what consumers can use it for.
A current refrain in financial commentary is that tariffs — taxes on imported goods, paid by Americans — increase inflation. This is not technically accurate. Tariffs certainly raise the cost of items on which they are imposed. That is their design: Protectionists favor tariffs because they make foreign goods more expensive, driving people to buy domestic alternatives that are costlier to produce.
Yet tariffs cannot increase inflation, which does not mean higher prices on some things some of the time, but a sustained rise in the “general price level” of all goods and services across the economy. As Milton Friedman memorably explained, this sort of inflation is “always and everywhere a monetary phenomenon,” for a simple reason. Everyone in the economy cannot spend more money on everything at once, unless they have access to additional money.
We recognize this limit in our personal budgets. When the price of gasoline goes up, and you still need to fill your tank every week, you have less money available to spend on food, clothing, or movie tickets. You will have to cut back somewhere. The only way that you can spend more on everything you buy each month is if your income rises, so you have more money in your bank account.
Inflation is what happens when the sum of everyone’s bank accounts — or the total amount of money held by people in an economy — increases faster than the actual supply of goods and services. When everyone has more money to buy a limited number of things, prices must go up for the market to clear. Some prices rise more than others, and some may even fall, but the average rate of price increases should roughly equal the rate of increase in the money supply minus real economic growth. That is the measure of how much new money is chasing too few goods.
We can test this formula with U.S. inflation since the pandemic. Since the beginning of 2020, the amount of money in circulation has risen by about 44 percent, driven by expansionary fiscal and monetary policy. The consumer price index — the official measure of the price level used to track inflation — rose by 27 percent in the same period. Almost all the remaining increase in the money supply, 17 percent, was matched by real economic growth of 16 percent.
Think of it this way: Of all the new money created since 2020, only a third is being used to pay for goods and services that did not previously exist. The rest is going toward things that were already being produced, bidding up their prices. Inflation doesn’t mean that Americans have less to spend. Rather, inflation can only exist when Americans have too much to spend.
If the U.S. economy were a single entity, inflation would not make it any poorer. It would still receive all the goods and services it used to produce. Prices would be higher nominally, but that would translate into equally higher incomes on the other end.
Why, then, does inflation make so many people feel poorer? The answer is that when the government creates new money, it does not flow evenly to everyone. Some individuals gain access to new money before others and can spend it before anyone else, paying inflated currency for non-inflated prices. As the new money circulates through the economy, it raises the prices of everything it touches. Many people see these higher prices but do not see new money in the form of higher incomes until much later, if ever. Inflation reduces their purchasing power by redistributing it, shifting consumption of goods and services toward those who had earlier access to new money.
Logically, someone must be paying every inflated price, so not everyone is materially worse off. Have you ever walked through a checkout lane, seen a pack of gum selling for $6, and wondered, “Who would pay that much?” As a matter of fact, someone will pay that much. If they did not, the store wouldn’t be selling gum at that price. It would sell the gum for less, or not sell it at all.
Because tariffs do not increase the money supply, they cannot cause widespread inflation. They raise prices for some goods, but without a commensurate increase in money to buy them, consumers are unable to spend more in one area without spending less elsewhere. If they spend less elsewhere, prices of other goods must fall to meet reduced demand. Those lower prices cancel out the higher prices from tariffs in the overall price level, so no inflation occurs.
But therein lies the rub. Tariffs do not merely redistribute purchasing power, making one set of consumers better off at the expense of others. They destroy everyone’s purchasing power by limiting how it can be employed.
Say a household is facing higher prices on a tariffed good — which they currently are — whether it’s a new car or metal forks. They can pay the elevated price, reducing the money they have available to spend on everything else they may want. Or they may decide the price is too high and forgo the item they would have otherwise bought. Either way, they do not get to spend their money the way they would prefer, and they derive less overall value from their consumption.
Now that monetary inflation has subsided (for the most part), noticeable price hikes are increasingly explained by tariffs and the supply-chain disruptions they cause. The Wall Street Journal reports that “shoppers are buying less where prices are rising fastest,” showing that higher prices are not “being driven by demand but by companies passing on costs.” This phenomenon is concentrated in durable-good categories reliant on imports, such as audiovisual equipment, tableware, sporting gear, luggage, and furniture. On these and similar items, Americans are spending much less.
Inflation is a scourge, but at least it impoverishes only most people. Tariffs impoverish everyone who buys stuff, and thus the nation at large.