US Tariff Hikes Might Backfire With 'Significant' Initial Impact, Says Citi

A tariff hike by the United States on other countries will result in a sustained output loss with a "quite significant" initial impact, according to Citi Research.

The US is the origin and target of multiple shocks, whereas the other trading partners only see their bilateral trading relationship with the US affected, Citi said in a note. The brokerage simulated a tariff increase on the country's major trading partners by 10 percentage points. This includes a retaliation by its trading partners with a similar hike in US imports.

The initial impact on US GDP growth is therefore quite significant, with a peak loss in output of around 1.5%, Citi said. This is followed by a growth rebound, partly because of a supportive Fed reaction, which is, however, not sufficient to offset the initial downturn, it added.

However, Citi refrained from overfitting the simulation by introducing discretionary fiscal policy responses.

Former US President and Republican presidential candidate Donald Trump has been campaigning to impose a reciprocal tax on countries like India if re-elected. Trump also criticised India for imposing high tariffs on foreign goods.

"The output loss in the rest of the world is persistent, too, though a little less pronounced," it said. The results suggest longer-lasting loss in trade growth and a less integrated global economy for a number of years after the shock, it added.

While the US GDP growth will stabilise within a few years after the hike and retaliation, the same is not true for global trade growth, which will still be on a rather slow recovery, it said. "As a result, global integration—proxied by the ratio of trade to GDP—will decline for a while."

While the reasons for the magnitude of US current account deficits require a discussion exceeding the scope of this note, the results support the view that tariffs will not help much in addressing this perceived problem.