Analysis reveals optimal tariffs significantly lower than foreign tariffs, highlighting trade dynamics.
Abstract We develop simple formulas for calculating optimal retaliatory tariffs in interna-tional trade disputes. These formulas correct reciprocal tariff rates for distortionsin exchange rates, interest rate differentials, and capital flows that occur due toforeign tariffs. We also conduct a welfare comparison between reciprocal tariffs andoptimal tariffs. The analysis reveals a stark but unsurprising insight: allowing themarkets for capital and currency to operate freely eliminates the need to retaliatevia tariffs to a significant extent. For realistic parameter values, a 15% foreign tariffcan be countered by an optimal tariff rate of only between 2.1% to 2.4%. JEL Classification: F13, F21, F32.
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Khan et al. (2025) studied this question.
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