Ben Bernanke in Doha: The Effect of Monetary Policy on Optimal Tariffs
Trade liberalization can imply slow and long adjustment processes.
Taking account of these adjustment processes can change the evaluation
of trade policy, especially when policy makers care more about the next
couple of years than the infinite future. In this paper I analyze the setting
of tariffs in a two-country model taking account of adjustment processes
with special emphasis on the effects of nominal price rigidity and mone-
tary policy. I show that nominal price rigidity induces policy makers with a short planning horizon to set lower tariffs because it enhances the short-run drop in consumption following an increase in tariffs. Monetary policy that aggressively fights deviations from its inflation target implies even lower optimal tariffs.