Global Networks, Monetary Policy, Trade

Sebnem Kalemli-Ozcan, Can Soylu and Yıldırım, Muhammed A.

No 20168, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We develop a multi-country, multi-sector New Keynesian model with incomplete markets, input-output linkages, and heterogeneous sectoral price rigidities to study the macroeconomic effects of tariffs. Tariffs act simultaneously as demand and supply shocks. A risk-sharing wedge, driven by terms-of-trade effects and revalued net foreign assets, summarizes the wealth transfer in general equilibrium and determines whether the tariff-imposing country gains or loses. This wedge interacts with a propagation matrix encoding network structure, sectoral rigidity, and cross-country monetary policy heterogeneity, which governs how inherited real marginal-cost distortions feed into inflation and consumption. Through input-output linkages, transitory tariffs generate persistent distortions, unlike standard New Keynesian benchmarks. These distortions exceed what N-country monetary policy can offset, even under flexible exchange rates. Quantitatively, the 2025-2026 tariffs are stagflationary for the U.S. and yield inflation or deflation abroad depending on trade diversion and monetary policy heterogeneity. Tariff threats alone generate inflation shaped by retaliation expectations.

Keywords: Tariffs; Input-output linkages; Incomplete markets; Inflation expectations; Exchange rates; Trade imbalances (search for similar items in EconPapers)
JEL-codes: E2 E3 E6 F1 F4 (search for similar items in EconPapers)
Date: 2025-04
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