A dynamic model of tariffs,output and employment under flexible exchange rates

A portfolio balance model of the open economy with imperfectly flexible wages and rational expectations is used to analyze the macroeconomic effects of commercial policy. Previous analyses have led to the ‘counterintuitive’ and ‘almost inconceivable’ conclusion that, under flexible exchange rates, a tariff is contractionary. By considering a tariff in a dynamic setting and focusing on the process of adjustment, it is shown that there may exist a tradeoff between a tariffs short-run and long-run effects. In certain circumstances, a tariff imposed under flexible exchange rates increases output and employment initially while reducing them subsequently.