Fear of floating and trade wars (joint with Masashige Hamano and Maria Teresa Punzi)

Abstract :
In this paper, we extend the framework of Hamano and Pappadà (2022) to explore the response of optimal monetary policy to uncoordinated trade policies. Our analytical results show that optimal monetary policy is expansionary following a foreign tariff hike. In turn, the optimal tariff policy takes protectionist measures against foreign expansionary monetary policy in order to mitigate undesirable reallocation in exporting markets. We calibrate our model to show the extent of the fear of floating and trade retaliation from a quantitative standpoint.