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Faculty of Economics


Bergin, P. R. and Corsetti, G.

The Macroeconomic Stabilization Of Tariff Shocks: What Is The Optimal Monetary Response?


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 elements from the trade literature, including global value chains, firm dynamics, and comparative advantage, 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: comparative advantage, optimal monetary policy, production chains, tariff shock, tariff war

JEL Codes: F40

Author links: Giancarlo Corsetti  


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Grant: Brexit Project