Working Paper: CEPR ID: DP16827
Authors: Olivier Jeanne
Abstract: This paper presents a tractable model of a global economy in which countries can use a broad range of policy instruments---the nominal interest rate, taxes on imports and exports, taxes on capital flows or foreign exchange interventions. Low demand may lead to unemployment because of downward nominal wage stickiness. Markov perfect equilibria with and without international cooperation are characterized in closed form. The welfare costs of trade and currency wars crucially depend on the state of global demand and on the policy instruments that are used by national policymakers. Countries have more incentives to deviate from free trade when global demand is low. Trade wars lower employment if they involve tariffs on imports but raise employment if they involve export subsidies. Tariff wars can lead to self-fulfilling global liquidity traps.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| low global demand (F69) | higher unemployment (J64) |
| tariffs on imports (F13) | lower employment (J63) |
| export subsidies (H20) | raise employment (J68) |
| tariff wars (F13) | self-fulfilling global liquidity traps (F65) |
| self-fulfilling global liquidity traps (F65) | lower employment (J63) |
| low global demand (F69) | stronger incentives to deviate from free trade (F13) |