Tariffs and the current account

Abstract

This paper examines the impact of a tariff on the current account in a model which emphasizes the fact that it takes time for the production sector of an economy to adjust to a change in relative prices. Income effects of the adjustment lead to a transitory current-account surplus because the deleterious effect of the tariff on national income is larger in the long run than in the short run. In addition, relative prices ‘overshoot’ in response to the tariff, leading to an increase in the consumption rate of interest which, in turn, generates an increase in desired saving.

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