Optimal trade policy in tariff games with inside money

We construct a bilateral trade model incorporating two physical goods and a financial asset (inside money) to discuss the optimal trade policy that countries would choose to maximize their respective utilities. In this Nash tariff game, the trade of physical commodities only occurs geographically across countries, and the trade of inside money allows for intertemporal allocation of consumptions. When the preferences, present and future endowments for each country are given, according to our numerical analysis, trade surplus or deficit (inside money) and optimal tariff rates are endogenously determined when general equilibrium conditions hold. One country may purchase inside money to shift current consumption to the future, and the other may be willing to issue inside money for smoothing its consumptions in two periods. This imbalance trade contradicts traditional trade models which imply a balanced trade policy. We further find that the price of inside money as an implied interest rate also is determined by the trade intervention policies.