Expected versus unexpected Inflation:The role of Trade Policy

Abstract

This paper investigates how trade policy shocks, specifically tariffs, distinctly affect the 1-year expected versus unexpected components of U.S. inflation. Using a Bayesian structural vector autoregression model and monthly data from 2007 to 2025, we decompose headline inflation to uncover a powerful and nuanced role for trade policy. We find that tariffs have a statistically significant and positive long-run impact on unexpected inflation. In contrast, while a tariff shock does not produce a statistically significant response in the level of expected inflation, our variance decomposition reveals it is the single largest long-run contributor to its volatility. These effects are distinct from short-run dynamics, where oil prices primarily drive inflation surprises. We also identify a formal structural break in May 2018, after which the effects of monetary policy grew to overshadow those of trade policy. A counterfactual analysis confirms that in the absence of tariff shocks, the inflation path would have been different. A key implication is that trade policy, through tariffs, creates significant long-term uncertainty for inflation expectations, complicating the task of maintaining price stability.