Tariff shocks and economic policy

Optimal monetary policy in the face of tariff shocks: expansion or contraction?

Paul Bergin and Giancarlo Corsetti discuss the optimal monetary policy responses to tariff shocks, particularly in light of recent political developments and the potential for increased trade tensions. They use a standard open-economy New Keynesian (sticky-price) model augmented with international value chains in production and assume substantial pass through of tariffs to consumer prices.

Key findings

The optimal monetary response to tariff shocks is not always straightforward and depends on several factors.

• Factors Influencing Optimal Monetary Response
  The authors highlight three key factors that play a crucial role in determining the appropriate monetary policy:
  – Likelihood of retaliation: If tariffs are likely to be reciprocated in a trade war, this changes the optimal policy response.
  – Reliance on imported intermediates: The share of imported inputs in domestic production affects the supply-side implications of tariffs.
  – Currency dominance: The special role of the US dollar as the dominant currency in international trade influences the effectiveness of monetary policy.
• Trade Wars and Monetary Policy
  In the case of unilateral tariffs without retaliation, monetary tightening may be appropriate to moderate inflation and offset distortionary effects on relative prices. However, in the case of a symmetric tariff war, monetary expansion may be the optimal response, despite inflationary pressures.
• The Role of the US Dollar
  The authors emphasize the unique position of the US due to the dollar’s role as the dominant currency in international trade. This implies that the US can rely more heavily on monetary policy as a stabilization tool and in a tariff war scenario, the optimal US monetary response may be more expansionary compared to other countries.  This asymmetry can lead to different policy responses between the US and its trading partners.

Tariff shocks combine elements of both demand and supply disturbances, and monetary policy is bound to face a difficult trade-off between moderating inflation and supporting economic activity; in fact, a reasonable calibration of our model indicates that the optimal monetary response to such a scenario may well involve monetary expansion.

Monetary policy in response to tariff shocks
By: Paul Bergin, Giancarlo Corsetti – University of California, Davis, European University Institute

Alternatives to Trump’s trade policies

In this article Anne Krueger discusses alternatives to Trump’s announced trade tariffs. She argues that Trump’s previous tariffs during his first term are estimated to have cost the average American household more than $1,000 annually. While import competition has caused job losses, technological advances have been the primary driver of US job losses. If the goal is to provide meaningful relief to workers displaced by import competition then there are better alternatives to achieve it.

Proposed Alternatives

• The author suggests making import tariffs conditional, requiring producers benefiting from trade protections to refrain from hiring additional workers unless protections are lifted. “This approach would help ensure that the costs of such measures do not become permanent.”
• A more targeted adjustment program is proposed to replace the Trade Adjustment Assistance Program (TAA). This program would offer:
  – Generous adjustment assistance for older displaced workers
  – Unemployment benefits, job-placement services, and financial assistance   for relocation for younger workers, provided they enroll in approved retraining programs.

A Better Alternative to Trump’s Tariffs
By: Anne O. Krueger – Johns Hopkins University