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The Macroeconomic Stabilization of Tariff Shocks: What is the Optimal Monetary Response?

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  • Paul R. Bergin
  • Giancarlo Corsetti

Abstract

In the wake of Brexit and the Trump tariff war, and a general weakening of the political support for free trade, central banks have been faced with the need to reconsider the role of monetary policy in managing the economic effects of unexpected hikes in tariffs and trade costs. Although tariffs induce a slowdown with rising inflation like supply shocks, their distortionary effects on production and relative prices distinguish them from standard supply disturbances, and thus motivate a different monetary response. This paper studies the optimal monetary stabilization of tariff shocks using a New Keynesian model enriched with elements from the trade literature, including global value chains in production, firm dynamics, and comparative advantage between traded sectors. We find that, in response to tariff shocks, the optimal monetary stance is generally expansionary: central banks support activity at the expense of further aggravating short-run inflation—contrary to the prescription of the standard Taylor rule. If the tariff is imposed unilaterally by a trading partner, currency depreciation partly offsets the effects of tariffs on relative prices, without completely redressing the effects of the tariff on the broader set of macroeconomic aggregates. Remarkably, the country issuing a dominant currency can shelter its economy from the adverse effects of a selective tariff war on comparative advantage.

Suggested Citation

  • Paul R. Bergin & Giancarlo Corsetti, 2020. "The Macroeconomic Stabilization of Tariff Shocks: What is the Optimal Monetary Response?," NBER Working Papers 26995, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:26995
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    References listed on IDEAS

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    1. Paul R. Bergin & Giancarlo Corsetti, 2020. "Beyond Competitive Devaluations: The Monetary Dimensions of Comparative Advantage," American Economic Journal: Macroeconomics, American Economic Association, vol. 12(4), pages 246-286, October.
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    1. The Macroeconomic Stabilization Of Tariff Shocks: What Is The Optimal Monetary Response?
      by Christian Zimmermann in NEP-DGE blog on 2020-06-29 20:30:56

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    Cited by:

    1. Olivier Jeanne, 2021. "Currency Wars, Trade Wars, and Global Demand," NBER Working Papers 29603, National Bureau of Economic Research, Inc.
    2. Jacquinot, Pascal & Lozej, Matija & Pisani, Massimiliano, 2022. "Macroeconomic effects of tariffs shocks: The role of the effective lower bound and the labour market," Journal of International Money and Finance, Elsevier, vol. 120(C).
    3. Marco A. Hernández Vega, 2021. "Tariffs and Macroeconomic Dynamics," Working Papers 2021-25, Banco de México.

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    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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