“Economists are often asked to predict what the economy is going to do. But economic predictions require predicting what politicians are going to do – and nothing is more unpredictable.”
– Thomas Sowell, American Economist
There has been ongoing debate about the impact of import tariffs on inflation. The common assumption is that tariffs lead to higher prices, which – in turn – drive inflation. While this may seem straightforward, the actual effects are more complex.
In some cases, businesses absorb the increased costs rather than passing them on to consumers. Supply chains may also adjust, sourcing cheaper alternatives to offset price increases, not to mention the automatic stabilizers of currency market adjustments. These factors can lessen the impact of tariffs.
While tariffs can contribute to price increases, they are not always a direct cause of inflation. The overall effect depends on various economic conditions, business responses, and market adjustments. Understanding these dynamics is essential to assessing whether and how tariffs will affect consumer prices.
How Can Price Changes Make Us Shop Differently? (Publix vs. Costco Edition)
Ever walked into Publix, grabbed your usual bag of coffee, saw the new price and immediately reconsidered all of your life choices? That’s basic economics messing with your morning routine.
Here’s the deal: when prices go up, people naturally buy less – it’s called the law of demand. But how much less depends on what economists call price elasticity, which is just a fancy way of asking, “How angry does this price hike make you?”
Imagine this: Publix suddenly doubles the price of your favorite coffee. If coffee is your lifeline to functioning like a normal person, you might still buy it – albeit begrudgingly, while muttering complaints at checkout. That’s inelastic demand: you’re hooked and they know it.
But let’s say you have options. Maybe you think, “Forget this, I’ll switch to tea, or maybe it’s time to finally use that Costco membership I swore I’d use more often.” If enough people jump ship, that means coffee has elastic demand: small price change, big reaction.
And then there’s Costco, where coffee comes in a tub the size of a toddler. Even if the price inches up, it still feels like a deal because you won’t need to buy coffee again until your grandkids graduate. That’s why bulk shoppers tend to shrug off minor price hikes while Publix shoppers feel personally attacked.
So the next time you’re standing in the coffee aisle, torn between paying up or driving to Costco, just remember: you’re not just shopping, you are starring in your own economics lesson, one overpriced cup of coffee at a time.
Dear Bond Market: Are You Shopping at Publix or Costco?
Just as coffee prices can make shoppers rethink their habits, bond prices can tell us a lot about what may happen in the future to the economy and general prices. Right now, the bond market is acting a little like a Publix shopper staring at a price tag, wondering if it’s time to head to Costco instead.
Treasury Inflation-Protected Securities (TIPS) are the investing world’s version of a real growth barometer: they adjust with inflation, ensuring returns aren’t eroded by rising prices. Regular Treasury bonds, on the other hand, are more “no frills” – what you see is what you get, regardless of inflation.
So what happens when TIPS yields rise? It means bond investors expect a strong economy, with real growth. But when TIPS yields fall, it’s a sign that bond investors are worried about real economic growth slowing.
Right now, the bond market is signaling future hesitation. The 10-year TIPS yield is dropping, along with future inflation expectations, meaning bond investors see weaker growth ahead. And while tariffs are usually blamed for short-term higher prices, bond market indicators suggest there might actually be a long-term cooling in prices instead.
This is getting reflected in real time, as shown in the chart below by Alpine Macro. The 10-year TIPS yields are falling, discounting slower real growth ahead.
The Japanese Experience: When You Hear Tariffs, Think of an Unwanted Sales Tax
Ever rushed to buy something before a price hike – like stocking up on gas before it jumps overnight or hoarding your favorite snacks before shrinkflation makes them microscopic? That’s exactly what happened in Japan every time they raised the Value-Added Tax (VAT).
Japan first introduced a 3% VAT in 1989 and, the moment it kicked in, prices shot up as businesses passed the cost onto consumers. People panic-shopped to beat the tax, creating a short-lived spending spree. But after the rush, reality hit: higher taxes meant less money in people’s pockets, and demand dropped like a bad karaoke performance.
Fast forward to later VAT hikes in 1997, 2014 and 2019, and the pattern repeated: prices spiked, then slumped, as consumer spending dried up. The long-term effect? A slow grind downward in prices, proving that while taxes might give inflation a short-term jolt, they often end up putting a damper on economic growth.
Now, here’s where tariffs come in. Like VAT, tariffs act as a tax – raising costs for businesses and consumers alike. And just like Japan’s VAT hikes, they might create an initial burst of inflation but, over time, they weigh on growth and spending. So the next time you hear “tariff,” just picture it as an extra tax sneaking into your shopping cart, except this one has a cooling effect on growth. The below chart from Alpine Macro highlights these episodes over time.
Final Thoughts: Tariffs Are Taxes, and the Economics of Sticker Shock
Tariffs, like surprise fees on your bill or that sneaky shrinkflation on your favorite snack, have a way of making prices jump – at least at first. But much like the Publix vs. Costco dilemma, the story doesn’t end there. Consumers adapt, businesses adjust, and markets find a way to even things out.
While tariffs might spark an initial burst of inflation, history tells us they often end up cooling things down in the long run. Think of it like a coffee price hike: first, there’s outrage, then some grumbling, and then, eventually, either you switch to tea or start buying in bulk. The economy works the same way.
So before assuming tariffs will send prices into orbit, take a peek at the bond market – it’s already whispering that future growth and inflation might actually be slowing. In the end, the economy, like a seasoned shopper, will finds a way to navigate the price tags. The real question is: are we in a Publix moment, or is it time to start thinking like a Costco shopper?
Either way, the slowing will likely pave the way for interest rate cuts later this year or in 2026. The expectation of interest rate cuts by the Federal Reserve may also renew the rally in stock prices. In the meantime, stock market volatility will be elevated.