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

Author

Listed:
  • Paul R. Bergin

    (University of California at Davis)

  • Giancarlo Corsetti

    (University of Cambridge)

Abstract
In the wake of Brexit and the Trump tariff war, central banks have had to reconsider the role of monetary policy in managing the economic effects of tariff shocks, which may induce a slowdown while raising inflation. This paper studies the optimal monetary policy responses using a New Keynesian model that includes elements from the trade literature, including global value chains in production, firm dynamics, and comparative advantage between two traded sectors. We find that, in response to a symmetric tariff war, the optimal policy response is generally expansionary: central banks stabilize the output gap at the expense of further aggravating short-run inflation---contrary to the prescription of the standard Taylor rule. In response to a tariff imposed unilaterally by a trading partner, it is optimal to engineer currency depreciation up to offsetting the effects of tariffs on relative prices, without completely redressing the effects of the tariff on the broader set of macroeconomic aggregates.

Suggested Citation

  • Paul R. Bergin & Giancarlo Corsetti, 2020. "The Macroeconomic Stabilization of Tariff Shocks: What is the Optimal Monetary Response?," Discussion Papers 2017, Centre for Macroeconomics (CFM).
    • Handle: RePEc:cfm:wpaper:2017
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    References listed on IDEAS

    as
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    As found by EconAcademics.org, the blog aggregator for Economics research:
    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:

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    3. Olivier Jeanne, 2021. "Currency Wars, Trade Wars, and Global Demand," NBER Working Papers 29603, National Bureau of Economic Research, Inc.
    4. 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).
    5. Simon P. Lloyd & Emile A. Marin, 2023. "Capital Controls and Free-Trade Agreements," Discussion Papers 2306, Centre for Macroeconomics (CFM).
    6. Masashige Hamano & Francesco Pappadà & Maria Teresa Punzi, 2023. "Optimal Monetary Policy, Tariff Shocks and Exporter Dynamics," Working Papers 2309, Waseda University, Faculty of Political Science and Economics.
    7. Yang, Shanran & Shi, Benye & Yang, Fujia, 2023. "Macroeconomic impact of the Sino–U.S. trade frictions: Based on a two-country, two-sector DSGE model," Research in International Business and Finance, Elsevier, vol. 65(C).
    8. Hernández Vega Marco A., 2021. "Tariffs and Macroeconomic Dynamics," Working Papers 2021-25, Banco de México.

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    More about this item

    Keywords

    tariff shock; tariff war; optimal monetary policy; comparative advantage; production chains;
    All these keywords.

    JEL classification:

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

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