PROVIDENCE – Import tariffs, once seen primarily as instruments to protect domestic industries under the guise of improving trade balances, are now being used to weaken geopolitical rivals and create strategic uncertainty. Its new uses even extend to coercing allies to cede territory, with the Trump administration threatening eight European countries with additional tariffs in an attempt to gain control of Greenland – all under the banner of national economic security.
However, much of the debate over tariffs, including Trump’s threats to Greenland, is based on outdated economic frameworks that ignore a defining feature of the modern global economy: deeply interconnected networks of production and finance.
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Thanks to these networks, tariffs can produce results that are very different from those predicted by traditional economic models. Rather than causing limited and temporary distortions, they can generate persistent inflation, significant production losses and powerful international spillovers, with uncertainty related to the threat of tariffs spilling over into the financial realm – effects that may take some time to materialize.
The reason is simple: in today’s economy, tariffs are not only a demand shock, but also a supply shock. While it is still true that tariffs shift demand away from goods produced domestically, domestic production now relies heavily on imported intermediate inputs.
From manufacturing components to energy, logistics and business services, companies source inputs globally and rely on complex supply chains and cross-border financial networks. When tariffs increase the cost of imported inputs, companies’ marginal costs and those of doing business anywhere directly rise.
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These higher costs then propagate across sectors and countries through production networks. Industries that appear to be only indirectly exposed – such as downstream services or manufacturing – could experience significant cost increases and pricing pressures.
As a result, tariffs distort not only what consumers buy, but also how companies produce and invest. As production declines, productivity falls and inflationary pressures emerge far beyond the sectors initially targeted.
Worse still, this inflation may last. In many industries, companies change prices infrequently, due to preexisting contracts, adjustment costs, or strategic considerations. These cases of nominal rigidity mean that cost shocks do not translate into immediate changes in prices, but rather unfold gradually.
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And, in a multi-sector economy with linkages between inputs and outputs, this gradual adjustment generates persistent effects, because past price changes continue to affect current inflation. Even after the tariff shock disappears, its effects can remain as higher costs are reflected in the production network.
This mechanism fundamentally changes the trade-off between inflation and output that central banks face. Inflation does not increase as a one-off jump, but as a prolonged process. To contain it, monetary policy must remain restrictive for longer, amplifying production losses.
The economy can therefore experience stagflation – rising inflation accompanied by falling production – even when tariffs are temporary. Furthermore, this result does not require extreme assumptions about import substitution (if or when a country replaces foreign goods with domestically produced goods).
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Even though companies can change suppliers over time, complementarities in production networks ensure that adjustment to temporary tariffs will be slow and expensive.
Tariffs also reshape global financial dynamics. Typically, in economies with incomplete financial markets, exchange rates respond not only to relative prices but also to wealth transfers induced by trade policy.
When a large economy imposes tariffs, its currency appreciates, reflecting a change in global demand and a transfer of purchasing power to the country imposing the tariffs. Although the trade balance may improve initially, exchange rate appreciation implies sustained trade deficits over time.
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Why, then, has the dollar depreciated since US President Donald Trump launched his global tariff war last April? The answer is that the economic impact of tariffs is not limited to their implementation.
Tariffs announced but not implemented can be equally disruptive, and additional uncertainty regarding trade and economic policy can weaken the currency of the country imposing them, as has happened in the US over the past year.
When companies and families anticipate future trade barriers, they immediately adjust their behavior, anticipating imports, revaluing currencies and reviewing consumption and investment plans.
If financial intermediaries require additional precautionary savings and higher risk premiums, the dollar depreciates even with small or merely threatened tariffs.
These expectation-driven adjustments can generate deflationary pressures and production losses even before any tariffs are imposed.
Thus, uncertainty itself becomes a powerful transmission channel for trade policy, increasing volatility in goods and financial markets.
Given this dynamic, three lessons stand out. First, trade policy cannot be evaluated apart from production networks. Models that ignore input and output linkages within global production networks and supply chains systematically underestimate production losses and fail to capture the persistence of inflation.
Second, monetary policy plays a decisive role in defining the outcomes of tariffs. Passive monetary policy allows inflationary pressures to persist, while aggressive tightening deepens recessions. Furthermore, the responses of foreign central banks are as important as those of domestic central banks in determining global outcomes.
Third, in a world of global value chains, tariffs are not a localized policy tool. They are a global macroeconomic and financial shock, regardless of their objective, with effects that spread across borders, sectors and time through global networks and financial market expectations.
As governments reconsider the use of tariffs in pursuit of national economic security or geopolitical influence, they must recognize that the costs extend far beyond the targeted industries and countries, creating risks for their own countries.
In today’s interconnected economy, tariffs and tariff threats are not precise instruments with predictable effects. They are a blunt and destabilizing force that can easily generate global stagflation if introduced without taking into account the underlying structure of global production.
Translation by Fabrício Calado Moreira
Şebnem Kalemli-Özcan, professor of economics at Brown University and director of the Global Linkages Lab, is a former senior policy advisor at the International Monetary Fund and former chief economist for the Middle East and North Africa at the World Bank.
Copyright: Project Syndicate, 2026.
