Tariffs: The Curious Case of the Missing Price Spike

The initial impact of new tariffs on consumer prices has, for many economists, proven surprisingly muted. However, recent economic data and corporate earnings reports are helping to illuminate why this has been the case and what might lie ahead. The answer lies in the dynamic reactions of both foreign exporters and domestic importing firms, combined with the role of inventories.

The Initial Shock Absorbers

When the new US tariff regime was first announced, its precise magnitude and duration remained uncertain. This ambiguity led many exporters and domestic importing companies to make a crucial calculation: absorbing the initial cost was preferable to immediately risking alienating consumers. The worry was that significant price hikes, introduced for a potentially temporary and reversible policy, could damage customer loyalty and market share.

Accordingly, rather than substantially raising their selling prices, many businesses chose to absorb the tariff costs within their profit margins. This strategy provided an initial buffer for consumers. Furthermore, some domestic companies had proactively accumulated significant inventories of imported goods ahead of the tariffs' implementation. This stockpiling offered them additional flexibility, allowing them to continue selling goods at pre-tariff prices for a period, further delaying the pass-through of costs to the consumer.

Looking Ahead: The Gradual and Partial Pass-Through

While these buffering mechanisms have played a significant role, recent indications suggest that the initial era of significant tariff absorption may be evolving. As uncertainty over tariff levels recedes and existing inventories diminish, companies are beginning to face more challenging, longer-term decisions about pricing and profits.

The degree to which these tariff costs will eventually be passed on to consumers is unlikely to be uniform. Businesses that sell products with inelastic demand (where consumers are less sensitive to price changes) are more likely to pass on a larger portion of the tariff cost increases. Conversely, companies facing elastic demand, particularly those serving lower-income consumers, will find it far more challenging to raise prices without risking significant demand destruction.

Indeed, rather than a broad and generalized effect, the pass-through of tariffs to prices could well vary significantly not just from sector to sector, but also from company to company, and even from product to product, reflecting differences in pricing power, demand elasticity, product differentiation, and competitive pressures.