Tariffs, Capital Controls, and Equilibrium Real Exchange Rates

A general equilibrium intertemporal model with optimizing consumers and producers is developed to analyze how the equilibrium real exchange rate reacts to changes in the degree of restrictions to intra- and intertemporal trade. In particular, the effects of changes in the level of import tariffs and of changes in taxes on foreign borrowing on the path of equilibrium real exchange rates are investigated. In the case of import tariffs, both temporary and anticipated changes are considered. It is shown that in this intertemporal framework equilibrium, real exchange rates can exhibit interesting and convoluted behavior. In particular, results that contradict the traditional wisdom can be obtained. A number of extensions are also discussed.