European Central Bank publishes working paper finding tariff-imposing countries bear more inflation while targeted economies face larger output losses

The European Central Bank has published Working Paper No. 3254 examining the short-run macroeconomic effects of a US-China tariff war in a multi-country, multi-sector New Keynesian model with production networks and different trade invoicing regimes. In the benchmark scenario, a reciprocal 10 percentage-point tariff increase across tradeable manufacturing sectors produces an asymmetric outcome: the country imposing the tariff absorbs more of the near-term inflation shock because import prices rise directly, while the targeted country suffers the larger output contraction through weaker foreign demand. In the paper's quantitative example, a US tariff on China cuts Chinese GDP by about six times the corresponding US output loss on impact, while US CPI inflation rises by roughly 0.13 percentage points. The paper finds that input-output linkages materially amplify and redistribute the shock beyond directly tariffed bilateral trade flows, with higher imported-input costs feeding downstream sectors and weaker export demand hitting upstream suppliers. Currency invoicing also changes the transmission path. Dollar pricing weakens the ability of exchange-rate depreciation to restore competitiveness, deepening the contraction in China relative to producer-currency pricing and altering spillovers to third countries. For the euro area, the aggregate effect is small, but only because positive trade diversion toward euro area suppliers is offset by weaker Chinese demand and broader multilateral adjustments. Sector-by-sector tariff experiments further show that incidence is concentrated in a small number of industries, but aggregate effects cannot be inferred from the tariffed sector alone because cross-sector propagation offsets own-sector gains in the US, reinforces losses in China, and leaves the euro area shaped by opposing trade margins.