Trade Policy Uncertainty and Inflation Tax Dynamics: Is the 'Most Beautiful Word' a Tax in Disguise?

Abstract Does trade policy uncertainty (TPU) erode consumers’ purchasing power? This paper addresses this question using a TPU-augmented structural New Keynesian Phillips Curve model and panel data from 44 countries spanning 1995–2020. We employ two complementary metrics of TPU: tariff overhang and news-based measures of trade uncertainty. Our results show that TPU has a positive and significant effect on inflation tax, with a one log unit increase in tariff overhang leading to a 4%–6% rise in inflation tax. The findings also reveal that trade structure plays a critical role in amplifying TPU’s effects, particularly in import-reliant economies where higher import prices exacerbate inflationary pressures. Furthermore, we note that exchange rate adjustments mitigate the inflationary impact of TPU under specific conditions, highlighting the interplay between trade and monetary dynamics. Overall, we find that TPU’s effect on inflation tax depends on exchange rate volatility, import prices, and their interaction, underscoring the complex mechanisms at play. These results emphasize the need for integrated policies that address both trade and exchange rate uncertainties to safeguard consumers’ purchasing power. JEL Classification : D80, E3, F1,.F13