Trade Wars and the Optimal Design of Monetary Rules

Stéphane Auray, Michael Devereux and Aurélien Eyquem

No 32451, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Monetary rules may have a large effect on the outcome of trade wars if central banks target the CPI inflation rate or more generally changes in the relative price of traded goods. We lay out a two-country open-economy model with sticky prices where countries engage in trade wars. In the presence of monopoly pricing markups, we show that the final level of tariffs and welfare losses from trade wars critically depend on the design of monetary policy. If central banks adopt a fixed nominal exchange rate or even better target the CPI inflation rate, trade wars are much less intense than those under PPI inflation targeting. We further show that an optimally delegated monetary rule that internalizes the formation of non-cooperative trade policy can actually completely eliminate a trade war, and even act to partly offset the welfare cost of monopoly markups.

JEL-codes: F30 F40 F41 (search for similar items in EconPapers)
Date: 2024-05
New Economics Papers: this item is included in nep-ban, nep-cba, nep-int, nep-inv, nep-mon and nep-opm
Note: IFM
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Working Paper: Trade Wars and the Optimal Design of Monetary Rules (2024)
Working Paper: Trade Wars and the Optimal Design of Monetary Rules (2024)
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