Trade Friction in Two-Country HANK with Financial Friction

This article develops the Two-Country HANK model(Heterogeneous Agents New Keynesian) in the context of trade frictions between China and the United States. Diverging from the conventional RANK (Representative Agent New Keynesian) model, our approach more accurately mirrors real-world economic dynamics by incorporating household heterogeneity and financial market frictions. Our investigation into the effects of reciprocal tariff impositions by these nations has revealed several critical insights. First, tariffs induce a measure of economic downturn in both countries. While a larger country can inflict more significant harm on a smaller one at a lower cost, it is not immune to output reductions. Second, the imposition of tariffs amid trade disputes alters the investment landscape of the smaller country, exacerbating the disparity in foreign investment holdings between wealthier and poorer households and thereby affecting wealth inequality. Lastly, although monetary policy can invigorate investment via financial leverage in the face of trade-induced recessions, its short-term benefits on output are constrained due to its limited capacity to boost labor effectively.