Working Paper: NBER ID: w25517
Authors: Stéphane Auray; Michael B. Devereux; Aurlien Eyquem
Abstract: This paper explores the relationship between exchange rate adjustment and trade policy in a simple New Keynesian open economy macro model. We show that movement in exchange rates have a direct implication for trade policy when governments choose tariffs endogenously. In particular, we show that the strategic incentive to impose trade restrictions is greater under flexible exchange rates than when exchange rates are fixed. This surprising result goes counter to conventional wisdom, which suggests that pressures to impose trade restrictions are greater when countries resist adjustments in exchange rates. But in fact, we show that the empirical evidence supports the model predictions. The paper goes on to characterize the path of equilibrium sustainable tariffs in the presence of sticky prices and flexible exchange rates. In our baseline model, tariff rates will rise in response to monetary policy shocks, but fall in response to productivity shocks. Estimating an SVAR model, we also find evidence in support of this prediction.
Keywords: endogenous trade protection; exchange rate adjustment; New Keynesian macro model
JEL Codes: F13; F33; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| exchange rate movements (F31) | trade policy (F13) |
| flexible exchange rates (F31) | strategic incentive to impose tariffs (F14) |
| monetary policy shocks (E39) | tariff rates (F13) |
| productivity shocks (O49) | tariff rates (F13) |
| supply shocks (E39) | protectionism (F52) |
| monetary policy shocks (E39) | protectionism (F52) |