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Trade and Currency Wars in the 21st Century

Paper Session

Friday, Jan. 4, 2019 2:30 PM - 4:30 PM

Atlanta Marriott Marquis, A601
Hosted By: American Economic Association
  • Chair: Olivier Blanchard, Peterson Institute for International Economics

The Macroeconomic Effects of Trade Policy

Christopher Erceg
,
Federal Reserve Board
Andrea Prestipino
,
Federal Reserve Board
Andrea Raffo
,
Federal Reserve Board

Abstract

We study the short-run macroeconomic effects of trade policies that are equivalent in a frictionless economy, namely a uniform increase in import tariffs and export subsidies (IX), an increase in value-added taxes accompanied by a payroll tax reduction (VP), and a border adjustment of corporate profit taxes (BAT). Using a dynamic New Keynesian open-economy framework, we summarize conditions for exact neutrality and equivalence of these policies. Neutrality requires the real exchange rate to appreciate enough to fully offset the effects of the policies on net exports. We argue that a combination of higher import tariffs and export subsidies is likely to trigger only a partial exchange rate offset and thus boosts net exports and output (with the output stimulus largely due to the subsidies). Under full pass-through of taxes, IX and BAT are equivalent but VP is not. We show that a temporary VP can increase intertemporal prices enough to depress aggregate demand and output, even when wages are sticky. These contractionary effects are especially pronounced under fixed exchange rates.

Currency Wars, Trade Wars and Global Demand

Olivier Jeanne
,
Johns Hopkins University

Abstract

I present a tractable model of a global economy in which countries attempt to boost their employment and welfare by depreciating their currencies and making their goods more competitive – a "currency war" – or by imposing a tariff on imports – a "trade war." Because of downward rigidity in nominal wages the global economy may be in a liquidity trap with less than full employment. In such a situation a trade war further depresses global demand and leads to large welfare losses (amounting to about 10 percent of potential GDP under our benchmark calibration). By contrast, currency war in which countries depreciate their currencies by raising their inflation targets restores full employment and leads to large welfare gains. The uncoordinated use of capital controls leads to symmetry breaking, with a fraction of countries competitively devaluing their currency and lending their surpluses to deficit countries at a low interest rate.

The Macroeconomic Effects of Trade Tariffs : Revisiting the Lerner Symmetry Result

Jesper Linde
,
Riksbank
Andrea Pescatori
,
International Monetary Fund

Abstract

We study the robustness of the Lerner symmetry result in an open economy New Keynesian model with price rigidities. While the Lerner symmetry result of no real effects of a combined import tariff and export subsidy holds up approximately for a number of alternative assumptions, we obtain quantitatively important long-term deviations under complete international asset markets. Direct pass-through of tariffs and subsidies to prices and slow exchange rate adjustment can also generate significant short-term deviations from Lerner. Finally, we quantify the macroeconomic costs of a trade war and find that they can be substantial, with permanently lower income and trade volumes. However, a fully symmetric retaliation to a unilaterally imposed border adjustment tax can prevent any real or nominal effects.

Trade and Currency Weapons

Matthieu Bussiere
,
Bank of France
Agnes Benassy-Quere
,
Paris School of Economics
Pauline Wibaux
,
Paris School of Economics

Abstract

The debate on currency wars has re-emerged in the wake of the exceptionally accommodative monetary policies carried out after the 2008 global financial crisis. Using product level data for 110 countries over the 1989-2013 period, we estimate trade elasticities to exchange rates and tariffs within the same empirical specification, using a gravity approach. We find that the impact of a 10 percent depreciation of the exporter country’s currency is "equivalent" to a cut in the power of the tariff in the destination country in the order of 2.4 to 3.4%. We then study the policy implications of these results based on a stylized macroeconomic model where the government aims at internal and external balance. We find that monetary and trade policies are imperfect substitutes and that the former is more effective in stabilizing output, except when the internal transmission channel of monetary policy is muted (at the zero-lower bound). One implication is that, in normal times, a country will more likely react to a trade aggression through monetary easing than through a tariff increase.
Discussant(s)
Oleg Itskhoki
,
Princeton University
Emmanuel Farhi
,
Harvard University
Giancarlo Corsetti
,
University of Cambridge
Katheryn Russ
,
University of California-Davis
JEL Classifications
  • F3 - International Finance
  • F1 - Trade