Global Economics Comment_ Will Tariffs Drive Hawkish Policy_ Evidence From VAT Increases (Briggs_Dong)

Summary of Key Points from Goldman Sachs Global Economics Comment Industry Overview - The report focuses on the potential impact of tariffs on inflation and Federal Reserve (Fed) policy in the context of the U.S. economy, particularly under the Trump administration's anticipated tariff announcements on China and European autos [2][3]. Core Insights and Arguments - Tariff Impact on Inflation: The baseline forecast anticipates a 3.4 percentage point increase in the U.S. overall effective tariff rate, which is expected to raise core Personal Consumption Expenditures (PCE) inflation by approximately 0.3 percentage points over the next 12 months [2]. - Fed's Reaction to Tariffs: The report questions whether the Fed will adopt a hawkish stance in response to tariff-driven price increases, noting that historical data provides limited insight due to few instances of tariff increases in modern economic history [3][4]. - Value-Added Tax (VAT) Analysis: The analysis uses data from over 70 VAT changes in developed markets (DM) to estimate inflation and policy responses, finding that a 1 percentage point VAT increase raises year-over-year inflation by 50 basis points for the next 12 months, with no significant long-term impact [6][7]. - Central Bank Responses: Historical evidence suggests that central banks have not responded hawkishly to one-time price increases driven by VAT changes, indicating a potential similar response to tariff-driven inflation [8][11]. - Inflation Overshoot Concerns: Despite concerns that recent inflation overshoots could lead to a more sensitive central bank response, the report finds no evidence of policy adjustments in high inflation periods following VAT increases [10][12]. Additional Important Points - Expectations for Fed Policy: The report concludes that the Fed is unlikely to raise rates in response to moderate inflation from tariffs, predicting a 50 basis point cut in 2025 and an additional 25 basis points in 2026 due to ongoing progress on underlying inflation [12]. - Caveats in Analysis: The analysis acknowledges that most VAT increases occurred in a post-2000 period of relatively benign inflation, which may not fully capture the current inflationary environment [10]. This comprehensive analysis provides insights into the potential economic landscape under the influence of tariffs and the Fed's likely policy responses, emphasizing the historical context of VAT changes as a parallel to understand tariff impacts.