The Mystery Deflation in the Fed’s Tariff Chart
Yesterday we explained that the New York Fed’s new tariff paper doesn’t really show that tariffs pushed inflation higher.
The paper does a much better job than earlier essays by the same set of economists at showing that a portion of the tariffs were passed through to consumers. But it doesn’t really show that this raised the general price level for consumer goods—much less the overall basket of consumer goods and services—rather than moving some prices higher and possibly pushing some prices lower.
What the Fed paper did was measure how much faster prices rose for goods more exposed to tariffs, directly or through their inputs. It then assumes that goods with no tariff exposure were unaffected—or at least goods the Fed economists think had no exposure—and treats whatever happened to them as if it would have happened anyway. That is the “counterfactual” non-tariff scenario they use to determine the effect of tariffs on goods prices.
In other words, they don’t demonstrate that tariffed goods prices would have moved like the non-tariffed goods actually did. And they don’t show that non-tariffed goods prices would have behaved like they did in the absence of tariffs. They just assume that this is the case.
In fairness to the Fed economists, they do explain this in their paper. But they do so in a way that almost no one who is not a professional economist will understand. You have to get all the way to page 20 to find that:
“This counterfactual should be read with care. Like any regression with time fixed effects, our specifications identify the effect of tariffs on a good’s price relative to less-exposed goods; the common, economy-wide component is absorbed by the date fixed effects and is not separately identified: the familiar missing-intercept problem. The counterfactual therefore treats these relative price effects as absolute ones, and should be read as illustrative of the magnitude of the tariff-induced price increases for the goods in our sample.”
Got that? The “familiar missing-intercept problem.” You know, that old thing. The “counterfactual therefore treats these relative price effects as absolute ones.” The eyes of even a seasoned lay reader of economic papers—including many journalists writing about this paper—glaze over. The counterfactual gets treated as a finding of the paper—prices would have fallen one percent without tariffs—rather than “read with care.”
But the Fed’s treatment of what happened doesn’t just deserve care. It deserves skepticism verging on scorn because the most likely scenario is that the rise in the price of tariffed goods was met with a decline in the price of the non-tariffed goods.
The NY Fed’s Chart Shows the NY Fed Is Wrong
Ironically, the best evidence that this is what happened comes from a chart included in the Fed paper and the write-up at the New York Fed blog, Liberty Street Economics.
The red line is actual price growth for the 67 goods categories in the study. The dashed blue line is what the Fed calls the “counterfactual without tariffs.” The shaded gap between them is the 2.9 percentage points everyone is quoting.
Consider what that dashed line claims. Through 2024, prices for these goods were barely falling, bottoming out around minus half a percent, and were climbing back toward zero as 2025 began. Then, according to the Fed’s counterfactual, goods deflation suddenly tripled, reaching roughly minus 1.5 percent late last year.
Why would that have happened? A simple continuation of the pre-tariff trend would have shown inflation moving higher, not a renewed plunge into deflation. Instead, their chart implies that prices would have suddenly and dramatically reversed course.
The answer is that the dashed line isn’t an independent forecast. It’s what’s left when you subtract the Fed’s tariff estimate from actual inflation. The method assumes that the leftover would have happened anyway, unaffected by tariffs. And the leftover plunges just as tariffs arrive.
The Fed’s chart stops in February 2026. Brian LeBlanc, chief economists at PNC, extended the calculation. This allows you to see what happens after the Fed’s cut off point.
LeBlanc applied the Fed paper’s published estimates to tariff exposures reconstructed from public data. (The New York Fed team, annoyingly, didn’t publish its list of what categories it counted as tariff-inflicted, so the rest of us have to try to reconstruct their data set.) His chart uses core goods inflation, so it is a reconstruction rather than a direct continuation of the Fed’s selected basket.
The extension makes the Fed’s flawed assumption even more striking. The supposed world without tariffs undergoes a sharp deflationary turn when tariffs arrive and an equally sharp recovery when their estimated inflation contribution fades.
This makes it all the more clear that the Fed’s no-tariff world requires two unexplained reversals. First, there’s a plunge timed exactly to the arrival of tariffs. Second, there’s the rebound timed exactly to their fading.
That’s quite a pair of coincidences. It’s a wonder that the chart did not set off alarm bells for the researchers that maybe the prices weren’t really moving independently.
Tariffs Move Some Prices Up, Others Down
A best explanation for what happened is the one we discussed yesterday. Higher prices for tariffed goods squeezed spending elsewhere, putting downward pressure on other prices. Tariffs didn’t give households additional spending power. So households lowered spending on some goods to pay for the higher prices of other goods. Paying more for a washing machine meant having less available for furniture, clothes, or a restaurant dinner. Once the tariffs were fully priced in, the squeeze eased and other prices recovered.
That is what the charts show. The prices the Fed treats as independent of tariffs moved in lockstep with them. They fall when tariffs arrived, and they rise when the one-time price effect wore off. Prices that respond to tariffs that precisely aren’t independent of them. They’re the other half of the tariff story.
In fancy economist speak, the New York Fed paper treats non-tariff prices as exogenous when they are endogenous. They move together, in opposite directions, rather than independently.
The Fed paper is on relatively solid ground when it is claiming that the prices of tariffed goods rose faster than the prices of other goods. Where it all goes wrong is when it leaps from that to “tariffs raised inflation.” That leap requires the prices of non-tariffed goods to be independent of tariffs. The Fed’s own chart suggests they are not.
The dotted blue line on the Fed’s chart doesn’t show a world without tariffs. What it suggests is that tariffs did not have a large effect on goods inflation at all. Instead, tariffs pushed down some prices as well as pushed up others.