Is it oil or tariffs pushing prices up?

A new statistical breakdown of the mid-2026 rise in inflation takes up the question that divides the Federal Reserve. Is the latest jump in prices mainly the work of hundred-dollar oil from the Persian Gulf, or of five months of universal 10 per cent import tariffs piling up?

Splitting the blame

Economists used vector autoregression (VAR) and input-output models of how prices pass through the economy to split the shock into its sources. The two causes turn out to be close to evenly matched, and equally unwelcome. Dearer crude and diesel account for about 55 per cent of the pick-up in headline inflation, feeding through freight charges and household energy bills. The universal tariffs explain the other 45 per cent, keeping prices rising for durable household goods, clothing and industrial equipment.

How the models work

The two tools answer different questions. A vector autoregression, the method Christopher Sims popularised in 1980, treats a handful of economic series as a system in which each depends on past values of all the others. By imposing assumptions about which shocks can move which variables first, economists can trace how a jolt to oil prices, say, ripples through inflation over the following months. Input-output tables, which the Commerce Department compiles from data on what each industry buys from every other, show how a cost increase in one sector spreads to the prices of everything that uses its output.

Oil passes through quickly and visibly. Petrol and household energy make up a significant slice of the consumer price index, so higher crude prices raise headline inflation within weeks. The indirect effects take longer: diesel raises freight costs, which raise the delivered cost of almost every good, and jet fuel raises airfares. Tariffs work more slowly, as importers run down stocks bought before the duty and then reprice, and their effect is concentrated in goods rather than services.

Why the split matters for the Fed

The decomposition matters because the two shocks behave differently over time. A tariff raises the price level once: after a year, if nothing else changes, the duty is fully reflected in prices and stops adding to inflation. An oil shock can go either way. If crude falls back when the strait reopens, energy prices will subtract from inflation and part of the rise will reverse. If it stays high, the indirect effects keep feeding through for months.

The split also looks different depending on which measure the Fed watches. The committee's preferred gauge is core inflation, which excludes food and energy. Energy's direct contribution does not appear in core at all, so the tariff share of the rise in core prices is probably larger than its 45 per cent share of the headline increase, while oil's influence on core comes only through freight and other indirect channels. Officials who focus on core may therefore see the problem as more about tariffs than the headline numbers suggest.

What the last tariffs showed

Evidence from the tariffs imposed in 2018 and 2019 is useful here. Studies of that episode found that almost all of the cost was passed on to American buyers through higher prices for imported goods, rather than absorbed by foreign exporters. There is little reason to expect a different result now. The last time America imposed a universal import surcharge, in August 1971, it was set at 10 per cent and lasted only a few months before it was withdrawn as part of the Smithsonian currency agreement. The current episode has already lasted longer.

Two shocks, no easy cure

An energy shock from abroad and a home-made tax on trade arriving together leave the Fed in a very awkward spot. Tighter monetary policy cannot fix either one, and both push nominal prices up while cutting what households can actually buy. Higher interest rates reduce demand, which eventually eases price pressure across the economy, but they do nothing to reopen a shipping lane or repeal a tariff. They work by making households and firms poorer on top of the squeeze they already face.

The textbook answer is to look through supply shocks and act only if they start to shift expectations. The difficulty is that two shocks arriving together make that harder to judge. Households who see petrol prices and the price of a new washing machine rising at the same time may conclude that inflation is here to stay, and ask for higher wages accordingly. That is the channel through which a temporary price shock becomes persistent inflation.

The limits of the numbers

Precise-looking splits should be treated with care. Estimates from vector autoregressions depend heavily on the assumptions used to identify each shock, and small changes can shift the shares noticeably. The two shocks also interact: tariffs on steel and equipment raise costs for energy producers, and higher freight costs raise the landed cost of tariffed imports. A 55 to 45 split is a useful rough guide rather than an exact accounting, and the conclusion that both shocks matter a lot is more dependable than the precise shares.

Households at the bottom of the income scale bear the most. They spend a larger share of their budgets on fuel and on the basic goods that tariffs affect, and they have the smallest savings to cushion the blow. Rate rises would add to their pain through higher borrowing costs on credit cards and car loans.

What to watch

Monthly consumer price data will show whether core goods inflation, the tariff channel, keeps climbing and whether services inflation starts to follow. The import price index will show how much of the tariff foreign exporters are absorbing. Survey and market measures of inflation expectations will show whether households and investors believe the shock will pass.

With oil and tariffs splitting the blame roughly 55 to 45, rate rises can do little about either, and inflation is likely to stay high while growth weakens until one of the two shocks goes away. The more likely candidate to fade first is the tariff effect, which should stop adding to inflation within a year of the duties being set; oil will decide the rest.