Working Paper: NBER ID: w31302
Authors: Stphane Auray; Michael B. Devereux; Aurlien Eyquem
Abstract: This paper shows that the outcome of trade wars for tariffs and welfare will be affected by the monetary policy regime. The key message is that trade policy interacts with monetary policy in a way that magnifies the welfare costs of discretionary monetary policy in an international setting. If countries follow monetary policies of flexible inflation targeting, trade wars are relatively mild, with low equilibrium tariffs and small welfare costs. Discretionary monetary policies imply much higher tariffs, high inflation rates, and substantially larger welfare costs. We quantify the effects of a global trade war among major economies using estimates of trade elasticities, economic size, net foreign assets and trade openness. We find large welfare benefits of an inflation targeting monetary policy for all countries.
Keywords: Trade Wars; Monetary Policy; Welfare; Inflation Targeting
JEL Codes: F30; F40; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Monetary policy (E52) | Incentive to impose tariffs (F14) |
| Flexible inflation targeting (E31) | Lower tariffs (F19) |
| Flexible inflation targeting (E31) | Better welfare outcomes (I31) |
| Discretionary policies (E60) | Higher tariffs (F19) |
| Discretionary policies (E60) | Elevated inflation rates (E31) |
| Discretionary policies (E60) | Larger welfare costs (D69) |
| Trade policy interacts with monetary policy (F42) | Magnifies welfare costs of discretionary monetary policy (E19) |
| Optimal tariff under flexible inflation targeting (E63) | Lower due to deflationary pressures (E31) |
| Optimal tariff under discretionary monetary policy (E63) | Higher due to manipulation of terms of trade (F14) |