The Optimal Monetary Policy Response to Tariffs

Abstract

What is the optimal monetary policy response to tariffs? This paper explores this question within an open-economy New Keynesian model, characterizes the macroeconomic effects of tariffs, and shows that the optimal monetary policy response is expansionary, with inflation rising above and beyond the direct effects of tariffs. This result holds regardless of whether tariffs apply to consumption goods or intermediate inputs, whether the shock is temporary or permanent, and whether terms of trade are exogenous or endogenous. When tariffs address other distortions, monetary policy remains expansionary, but the inflationary effects are mitigated.

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