Giancarlo Corsetti, European University Institute

"Monetary stabilization of sectoral tariffs" in combination with "Trading blows: The exchange-rate response to tariffs and retaliations"

Abstract (Monetary stabilization of sectoral tariffs)

This paper studies the optimal monetary stabilization of tariffs using a two-country, two-traded sector New Keynesian model, where tariffs imply inefficient sectoral reallocation as well as changes in aggregate output and inflation. We find that the optimal response to a tariff on imports of differentiated goods requires domestic currency appreciation to offset the tariff’s distortion on international relative prices. In our two-country environment, it is efficient for this exchange rate appreciation to be implemented primarily through monetary expansion in the foreign country; the monetary response in the home country is typically small, and can be either mildly expansionary or contractionary. Robust monetary expansion may nonetheless be appropriate when export prices are sticky in the local currency (LCP) and when the tariff is levied on the competitive non-differentiated goods sector.

Co-author: Paul R. Bergin, University of California at Davis

Abstract (Trading blows: The exchange-rate response to tariffs and retaliations)

This paper provides econometric evidence on how exchange rates respond to tariffs. We construct a new tariff-shock database, which captures tariff-related announcements, threats and implementations by the US, China, the euro area and Canada between 2018 and 2020, and in 2025. Our shock measure accounts for both the size of tariff rates and their economic relevance. We show that exchange rates react to US tariff shocks in systematically different ways depending on retaliation: the US dollar (USD) appreciates if the tariff is imposed unilaterally, but depreciates if other countries retaliate. This empirical pattern resonates with the predictions of recent open-macro models with dominant currency pricing. In light of our evidence and drawing on theory, we conclude that the USD depreciation following the US tariff announcement on 2 April 2025 was not surprising. The spike in long-maturity US Treasury yields was, however, more unprecedented.

Co-authors: Daniel Ostry and Simon Lloyd

For more information about Giancarlo Corsetti and his interesting work - link to his website.

Contact person: John V. Kramer