Output effects of a tariff under flexible exchange rates

Abstract

A tariff's impact on output is shown to depend on the asset market structure If foreigners do not hold the domestic asset, as is generally assumed in the previous literature, the tariff-induced current account surplus creates a large enough currency appreciation that demand for domestic output falls. When foreigners hold the domestic asset the current account surplus results in an international transfer of assets, which allows a smaller currency appreciation. The more similar are asset preferences across countries the smaller is the appreciation and, therefore, the greater is the likelihood that domestic output will increase.