Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

Abstract: We study the robustness of the Lerner symmetry result in an open economy New Keynesian model with price rigidities. While the Lerner symmetry result, i.e. the absence of allocative and trade-.ow effects of an equally-sized change in import tariff and export subsidy, holds up approximately for a number of alternative assumptions, we obtain quantitatively important long-term deviations under complete international asset markets. Direct pass-through of tariffs and subsidies to prices and slow exchange rate adjustment can also generate significant short-term deviations from Lerner. De- viations from symmetry, however, do not necessarily imply an impact on global output and are often limited to a redistribution of production and consumption across coun- tries. Finally, we quantify the macroeconomic costs of a trade war and find that they can be substantial, with permanently lower income and trade volumes. However, a fully symmetric retaliation to an unilaterally imposed border adjustment tax can prevent any sizable adverse real or nominal effects.

Keywords: Import Tariffs; Export Subsidies; Lerner Condition; Incomplete Markets; Complete Markets; Border Adjustment Tax; Trade War; New Keynesian open-economy model

JEL-codes: E52; E58

70 pages, December 1, 2018

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