Modelling the Impact of Tariffs

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The recent imposition of tariffs by the US has created significant market turmoil and debate about the impacts on the economy. Naturally, several economists have quickly produced research papers to estimate the potential impact of these tariffs. We will discuss two papers.

Quick Note – Predictions vs Causality

Before we dive into the papers, I’d like to emphasize that economics is generally a study that focuses on ‘causality’ type questions. In our current context, this would be focusing on the question of what impact will an X% tariff have on either GDP (Gross Domestic Output) or wages. These questions are a bit different from predictions, which focus on what will the GDP be next quarter or what will wages be next month. Predicting the value of a particular variable would require far more data, while the models used for such prediction often do not lend themselves to easy interpretation.1

The focus on causality by economists means that conclusions need to be interpreted very specifically. That is, if economists establish that a policy will cause GDP to fall by 1%, but actual GDP rises by 2%, that does not mean that economists were wrong. The economist's conclusion implies that had this policy not been implemented, GDP would have grown by 3%. 

New Keynesian Model

Kalemli-Ozcan, Soylu and Yıldırım (2025) (“KSY”) went about modeling what the impact of the US tariffs would be on the US and other countries. KSY used a New-Keynesian model for this purpose. At Nominal News, we have discussed this model often, as it is a ‘workhorse’ (foundational) model in economics. The key tenet of the New-Keynesian model is the assumption that prices (this includes wages) are ‘sticky’ – i.e. nominal prices (stated prices) do not adjust instantaneously. This assumption implies, for example, that firms cannot immediately lower prices during a recession, resulting in lower sales. Similarly, workers during a recession are also unable to work for lower