Modeling Trade Tensions: Macroeconomic and Trade Models in Different Institutions

Recent policy discussions have renewed interest in the effect of trade tariffs. As part of this ongoing debate, policy-making institutions are producing disparate estimates, which sometimes vary from one study to the next. What does account for those differences? Unlike typical macro policy changes, e.g. increase in monetary policy rates or taxes, tariff scenarios can vary greatly depending on the sectors or countries that are subject to the tariff, the retaliatory measures, and the persistence of the tariff increase. In addition, the analysis of tariff policies is carried out using two different frameworks. Trade economists in some institutions mainly rely on computable general equilibrium (CGE) models with considerable sectoral disaggregation, focus on input-output relations, but less emphasis on micro-foundations and dynamic adjustments. Macroeconomists in other institutions exploit dynamic stochastic general equilibrium (DSGE) models with considerably less disaggregation but more emphasis on dynamics, stock-flow consistency, policy rules, and expectations. In this paper, we bring side to side the models used in key institutions recently involved in the quantitative analysis of trade policies. We will show how different calibrations, pricing systems and short-term rigidities influence the main channels of transmission of tariff policies, delivering different strength of the expenditure switching and trade diversion phenomena that often accompany those policies. We will also show how incorporating some dynamic features in CGE models modify the main answer to the same policy questions and how their mechanisms compare to the DSGE, in the presence of a trade shock.