國
立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
19
* 0.005, i 0.75
, i 0.004. The steady-state tariff rate ( and *) for the import and export are specified as 0.17. The overall export demand X is set at 0.27, to have the balanced * current account in the steady state.9
5. Analysis
Assuming the small open country is negotiating a FTA, to let the tariff between two economies decrease or even turn to zero. This decrement will definitely increase the amount of both imports and exports. Generally, the decrement of tariff could proceed in two ways: (1) drop step by step or (2) decrease immediately in an amount in agreement. To simplify the analysis, we simply assume case 1 but only one step10. In the negotiation of FTA, both sides should take benefits in the agreement, which means both import and export tariffs should decrease. But it has difficulties in simulating two effects simultaneously, so we analyze separately.
We try to capture the effects when a tariff news is announced. We assume there is a news on tariff decrease four periods before the negotiation is completed and the policy is implemented.
In the following analyses, we assume four cases. First, we will compare the effects when the policy is preannounced and the effects if the policy comes as a surprise to see if there is an advantage for preannouncement or not. Second, we will compare the scenario with different length of period (1, 4 and 8) preannouncement to analyze if the duration plays an important role or not. Third, we simulate the possible situation that the negotiation takes more time than expectation which is four periods here. Forth, negotiation turns to fail, thus the tariff decrement
9 The calibrated value summarize into table 2
10 Considering the decreasing process of tariff in FTA will not turns down to zero immediately, the amount of decrement we assumed is 0.05, not full size 0.17.
‧ 國
立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
20
is not realized due to some frictions during the negotiation which cause the tariff reduction is higher or lower than the news announced before. 11
5.1 Case 1: Tariff decrement with and without preannouncement
In this case we simulate an unanticipated decrease in tariff, which is referred to a surprise shock on tariff. We can tell from figure 1 that the decrease in tariff directly lowers the cost of import firms. Based on the price setting, the firm will decrease its price to reflect the cost reduction which leads to greater demand for imports and thereby the consumption and investment. The lower import price reduces the aggregate price level which is composed of both domestic and import goods prices. Because the lower price pushes the demand up, the output of intermediate goods and the amount of domestic goods increase. Generally, the decrement in tariff can strengthen the economy through the increase in the aggregate demand.
However, things may go in the opposite way when we alert the tariff news ahead. We can find that in figure 2, the output in the economy is lowered after the tariff news is announced, and realize the effects of tariff decrement since the policy is truly implement. The reason is that final goods producer will expect a decrease in import prices in the future, and hence will postpone their consumption in intermediate goods when the prices are actually lowered.
Therefore, the decrement of final goods output restrain the consumption and investment, as well as intermediate output, drop after tariff news is announced. This decrement of aggregate output also decreases the demand for labor. Note that the real exchange rate will increase (real depreciation) just at the moment the news is announced due to the current account deficit caused by the recession on output The depreciation makes the costs of import firms higher and leads to higher import prices. However, when the negotiation is completed and the tariff is actually
11 The deviation from steady state is measure in quarterly effects. One should take summation of four period to see the effects of one year.
‧ 國
立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
21
lowered, the positive effects of tariff decrement starts to dominate. The lower price for importers dominates the nominal depreciation, and therefore leads to lower import prices. The dynamics will be same as the previous case when the tariff is lowered. The consumption and output are higher. Thus, the preannouncement of the signing of FTA may have a negative effect in the short run by lowering the output before the negotiation is completed and people maintain their expectation for tariff reduction.
5.2 Case 2: The time news on tariff reduction is released before implementation
The following analyses are all base on tariff news preannouncement. In case 2, we simulate the different periods of the preannouncement of tariff reduction before the policy is implemented.
For period 4, 1 and 8, we can obtain figure 2, 3 and 4, respectively. Note that, despite the path of impulse response functions look alike, how long the reduction of the output lasts and the time the economy recovers critically depend on the period between the announcement of tariff reduction and the policy is actually implemented. The result suggests that the earlier tariff decrement news is released, the more impact it may have on the economy in the short run.
5.3 Case 3: Policy delay
Another possible scenario is that it takes longer than expected to negotiate, so the actual implementation is postponed (we assume there is one year delay, in other words, 4 periods). The results are listed in figure 5. It is shown that this causes a kinked curve between the period the policy is expected to occur and it is actually implemented. This is just like the case unrealized what we going to analyze later. An interesting part is that, compared to the fully realized case, macroeconomic variables experience a sharper adjustment before the policy is implemented,
‧ 國
立 政 治 大 學
‧
N a tio na
l C h engchi U ni ve rs it y
22
and the output will not start to increase until the fifth period, then gradually rise until the policy is realized. After the policy is revealed, the output will rise at a faster pace.
5.4 Case 4: The tariff reduction is realized unexpectedly (news is unrealized or is realized at the size higher or lower than expectation)
There can be various frictions during the negotiation which may delay the process or even result in the failure. Therefore, we simulate various scenarios: (1) Negotiation fails and thus the government cannot meet people’s expectation. The result is listed in figure 6. (2) Although the contract is signed in the end, but the magnitude of tariff decrement is much lower than household’s expectation. The result is listed in figure 7. The results are quite intuitive. When the news is just announced, the two scenarios follow the same path, but move differently when the outcome of negotiation is realized. In the first case, the output does not rise above zero. Thus, the economy suffers the negative impact of news, but does not get any benefits. In the second case, the economic expansion is weaker if the realized tariff reduction is smaller than expectation, compared to that under the full realization.