Tariff, Consumption Home Bias and Macroeconomic Dynamics

Abstract

In this paper, New Open Economy Macroeconomics is served as an analytical framework to build a setting which is in line with structure of an imperfectly competitive market, we follow an open economy model with micro-foundation for two countries to explore the long-term and short-term effects of tariff shock on various macroeconomic variables (e.g. consumption, output, prices, exchange rate, terms of trade, and so on), and try to explain the role that consumption home bias plays therein. With theoretical derivation and simulation analysis, we find that the phenomenon such as undershooting, overshooting or mis-adjustment might happen to the dynamic adjustment process of each macroeconomic variable in face of domestic tariff shock while domestic and foreign consumers who have asymmetric behavior of consumption bias on the imported and exported goods.