Do tariffs truly reduce trade deficits? A new Yale-led paper—Tariffs and Trade Deficits—suggests the answer is yes, but at a cost. Recent U.S. tariffs do narrow the deficit, the researchers find, yet higher domestic prices erode Americans’ real consumption. And the adjustment isn’t as simple as fewer imports or more exports.

“Tariffs don’t just change imports and exports in a simple way. They set off global adjustments in income, spending, and financial flows,” Yale economist Samuel Kortum said. “The U.S. deficit shrinks, but because prices rise faster than consumption, the real economic cost falls on the U.S. consumer.”

Rethinking the models

The study’s result reflects not only new evidence, but also a new way of modeling how trade imbalances respond to policy. The research — led by Kortum and Lorenzo Caliendo, Won Park Hahn Professor of Global Affairs and Management — began with a puzzle: Why do the models economists most often use assume away the very possibility that tariffs could affect trade deficits?

Countries are assumed either to have perfectly balanced trade—imports always equal exports—or to have imbalances that are fixed and unchanging. In those setups, tariffs can shift trade flows but do not alter the size of a country’s deficit. “That felt like ivory tower economics,” Kortum explained. “It assumed away the very rationale policymakers were using when they argued that tariffs would reduce the U.S. trade deficit.”

The authors developed a framework that keeps the intuitive structure of a textbook trade model but allows trade balances to respond to policy changes. Their model captures how countries adjust not just trade flows, but also income and consumption when tariffs change.

Liberation Day and beyond

With data from 187 countries, the authors simulated the effects of several recent and proposed tariff shocks, including the “Liberation Day” tariff schedule announced by the U.S. in April 2025. The findings were consistent: higher U.S. tariffs narrow the trade deficit, especially in bilateral relationships with China, Mexico, Canada, and the European Union, where deficits shrink by one-third to one-half.

But the adjustment is uneven. In the U.S., income rises thanks to tariff revenue and higher wages, yet prices increase even faster, causing real consumption to fall. Meanwhile, some surplus countries, those that typically export more than they import, are able to cushion losses in income by adjusting their asset positions, leading in some cases to real consumption gains abroad.

What the results mean for policymakers

While the study does not weigh in on whether tariffs are good or bad policy, it does lay out the consequences of tariffs: what the model predicts will happen if tariffs rise. “We’re not making a big statement about how bad it is or how good it is,” Kortum said. “We’re saying: this is our best assessment of what will happen.”

That assessment points to a paradox for policymakers: tariffs may reduce trade deficits, but they do so by raising domestic prices and lowering real consumption. In effect, the burden of protectionist policies falls more heavily on the implementing country than on its trading partners.

A global perspective

Beyond the U.S., the model delivers a worldwide view of how tariffs ripple through the global economy. “The model can be informed by data on essentially all the countries of the world interacting and responding to U.S. tariffs,” Kortum said.

The authors see this as a foundation for future work. So far, the model focuses on short-run impacts—what to expect over a year or two. Next steps will involve extending the framework to say more about long-run standards of living and the cumulative effects of trade shocks over time.

For now, the findings offer a clearer lens for policymakers weighing the costs and benefits of tariffs. As Kortum put it: “Tariffs can reduce trade deficits. But the way they do it, and who ultimately bears the cost, is more complicated than the public debate often suggests.”

This story originally appeared on the Yale Cowles Foundation website