Working Paper: NBER ID: w26995
Authors: Paul R. Bergin; Giancarlo Corsetti
Abstract: In the wake of Brexit and Trump trade war, central banks face the need to reconsider the role of monetary policy in managing the inflationary-recessionary effects of hikes in tariffs. Using a New Keynesian model enriched with global value chains and firm dynamics, we show that the optimal monetary response is expansionary. It supports activity and producer prices at the expense of aggravating short-run headline inflation---contrary to the prescription of the standard Taylor rule. This holds all the more when the home currency is dominant in pricing of international trade.
Keywords: Tariff shocks; Monetary policy; New Keynesian model; Global value chains; Producer prices
JEL Codes: F4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| tariff shocks (F14) | fall in home production (D13) |
| expansionary monetary policy (E52) | alleviate negative effects of tariff-induced output declines (F69) |
| tariff shocks (F14) | rise in prices (E31) |
| expansionary monetary policy (E52) | support producer prices (L11) |
| expansionary monetary policy (E52) | aggravate short-run headline inflation (E31) |
| optimal monetary response to tariff shocks (E63) | expansionary monetary policy (E52) |