New research from the San Francisco Federal Reserve is challenging long-held assumptions about the relationship between tariffs and inflation, suggesting that steep increases in trade barriers may actually ease price pressures rather than drive them higher. The findings come as policymakers grapple with the economic implications of significantly elevated US import duties.

Historical Analysis Reveals Unexpected Pattern

The San Francisco Fed study examined approximately 150 years of historical data from the United States, France, and the United Kingdom. The research found that large tariff increases have historically coincided with rising unemployment and downward pressure on inflation, rather than the sustained price acceleration that many economists would expect.

This analysis takes on particular significance given the current trade environment:

Federal Reserve Policy Response

The Federal Reserve initially kept interest rates unchanged for much of last year due to concerns that tariffs would contribute to inflationary pressures. This caution reflected both theoretical economic models and empirical evidence suggesting that higher import costs would be passed on to consumers.

However, policy shifted by September as mounting signs of labor market weakness emerged alongside growing confidence that any inflationary impact from tariffs would prove temporary. The central bank ultimately reduced short-term borrowing costs by a total of 75 basis points in 2025 as economic momentum softened and inflation pressures continued to ease.

Modern Economy Considerations

The researchers acknowledged important limitations in applying historical patterns to today's economic landscape. The modern US manufacturing sector demonstrates far greater dependence on imported inputs compared to earlier periods, potentially making current tariffs more likely to generate cost pressures that flow through to consumer prices.

The study identified several factors that may explain why inflation historically declined during tariff episodes:

• Heightened economic uncertainty accompanying major trade policy changes
• Declines in equity markets during tariff implementation periods
• Reduced consumer confidence dampening overall demand
• Weaker asset prices offsetting direct price effects of higher import costs

Contemporary Economic Dynamics

Notably, the researchers did not assess how closely historical dynamics applied to last year's experience. While economic uncertainty rose sharply by several measures, US stock markets posted double-digit gains, supporting household spending and helping maintain overall economic growth resilience despite higher trade barriers.

Policy Implications

The findings contribute to an ongoing debate among policymakers about how tariffs influence inflation and economic growth. The research raises questions about whether central banks should treat trade-driven price pressures as temporary economic shocks rather than justification for prolonged monetary policy restraint.

The study suggests that interest rate cuts may represent an appropriate policy response if historical patterns continue to hold, though the unique characteristics of the modern economy warrant careful consideration in policy formulation.

The Federal Reserve's standing repo facility witnessed substantial demand on Monday, with financial institutions borrowing $25.95 billion through the overnight liquidity mechanism. This surge in borrowing activity reflects mounting quarter-end pressures in money markets as banks and financial institutions adjust their balance sheets to meet regulatory requirements.

Record-High Facility Usage

The Monday borrowing level represents the third-highest utilization since the Federal Reserve introduced the standing repo facility in 2021. The facility provides rapid, collateral-backed funding to eligible financial institutions on an overnight basis, accepting US Treasuries and mortgage-backed securities as collateral.

The borrowing was conducted at an interest rate of 3.75%, positioned at the upper end of the Federal Reserve's current policy rate target range of 3.50% to 3.75%. This elevated usage typically indicates tighter conditions in private funding markets, where borrowing costs can temporarily exceed the rates offered by the central bank.

Quarter-End Market Dynamics

Money markets routinely experience volatility around quarter-end periods as financial institutions manage balance sheet adjustments and comply with regulatory requirements. The latest usage level was last surpassed on December 1, when borrowing reached $26.00 billion, though it remains significantly below the all-time record of $50.35 billion recorded on October 31.

The standing repo facility serves as a critical liquidity backstop, ensuring short-term funding markets maintain smooth operations during stress periods. By offering funding at predetermined rates against high-quality collateral, the Federal Reserve aims to prevent sudden spikes in market rates and strengthen monetary policy transmission.

Reverse Repo Facility Decline

Concurrent with increased repo borrowing, data revealed a notable decline in the Federal Reserve's reverse repo facility usage. Financial institutions parked $10.55 billion in the reverse repo window on Monday, representing a sharp decrease from Friday's $20.34 billion.

This movement suggests a modest shift in liquidity conditions, with institutions moving from parking excess cash with the central bank to seeking overnight funding through the repo facility.

Market Liquidity Management

The contrasting movements in both Federal Reserve facilities underscore the dynamic nature of short-term funding markets and highlight the central bank's crucial role in managing liquidity as financial conditions evolve. These mechanisms provide essential market stability during periods when private funding markets experience temporary disruptions or elevated costs.