What are the likely consequences of uncertain US tariffs on the euro area economy and its monetary policy? The economic literature highlights three main conclusions. Without considering second-round effects through the exchange rate, a US import tariff is likely to drive up US inflation and have disinflationary and contractionary effects on its trading partner(s). However, the domestic inflationary effect can be offset if the US dollar appreciates (a simple general equilibrium model can illustrate these dynamics). A dollar appreciation tends to export the tariff’s inflationary impact from the US to the rest of the world, but the transmission of the exchange rate movement to prices is likely to be slower than the transmission of tariffs. Finally, trade policy uncertainty (distinct from actual trade measures) is unambiguously contractionary on all trading partners, dampening investment and economic activity.
The economic fallout of US tariffs will depend on three factors. First the nature of the actual tariffs that will be imposed: targeted tariffs on specific goods tend to have limited, sector-specific effects, while broad-based tariffs can drive inflation across the economy. Second, retaliation by trading partners: while some countermeasures have been introduced, they have thus far been softer than US tariffs, making US actions the primary driver of economic adjustments. Third, exchange rate movements: while the dollar’s response to tariffs can influence inflation and trade flows, currency shifts are driven by multiple factors beyond tariffs, making their overall impact more complex and difficult to predict.
Against this background, if the US imposes large and sustained tariffs on EU imports and the US dollar does not fully appreciate, the US will experience inflationary pressures, while euro area aggregate demand and output will likely contract. However, one cannot exclude a strong US dollar appreciation which could shift inflationary pressures from the US to Europe. Given these dynamics, the ECB should remain alert to both inflationary and deflationary risks and be prepared to adjust monetary policy as needed to maintain price stability.
About the Authors
Cinzia Alcidi is Senior Research Fellow at CEPS, where she is also head of the Economic Policy Unit and the Jobs and Skills Unit.
Ignazio Angeloni is a senior policy fellow with the Leibniz Institute for Financial Research SAFE at Goethe University Frankfurt and a non-resident fellow with the Institute for European Policymaking at Bocconi.
Cédric Tille is a Professor of Economics at the Geneva Graduate Institute for International and Development Studies.