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Policy Brief 22-4

For inflation relief, the United States should look to trade liberalization

March 2022

Note: The authors thank Madi Sarsenbayev for carefully reviewing data in this Policy Brief.

Enhanced competition reduces the cost of domestic goods

Based on Sherman Robinson and Karen Thierfelder’s computable general equilibrium (CGE) analysis,3 when imports are highly interchangeable with domestically produced goods (in technical terms, a “high elasticity of substitution”), CPI inflation would be reduced by 0.67 percentage point for each 1 percentage point decrease in tariff-equivalent import barriers.4 Substitution means that less expensive imported goods compete with more expensive domestic goods, leading to a shift in purchasing patterns and putting pressure on prices charged for domestic goods. As well, competition may compel domestic firms to trim their markup margins, especially in this era of high corporate profits.

Based on the Robinson-Thierfelder coefficient, the competitive impact of a 2 percentage point decrease in tariff-equivalent barriers could reduce CPI inflation by 1.34 percentage points (0.67 times 2 percentage points). From this figure, to avoid double counting, we subtract the 0.24 percentage point direct impact calculated above, giving a 1.1 percentage point reduction in CPI inflation for the competitive effect (see top row in table 2).