Optimal Monetary Responses to Tariffs According to HANK

Abstract

I characterize optimal monetary responses to tariff shocks in an open economy Heterogeneous Agent New Keynesian (HANK) model. Tariff shocks differ from supply or demand shocks due to the presence of a pecuniary fiscal externality; agents do not internalize how their spending increases fiscal revenue. When tariff revenue targets high marginal value households, the planner cuts rates, when revenue is spent in distributionally neutral ways, the planner expands less or even raises rates. The quantitative importance of the distributional impact of the tariff revenue for optimal policy remains whether terms of trade are endogenous, intermediates or final goods are tariffed, or preferences are non-homothetic