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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.
6. Conclusion
This paper analyzes the effect on macroeconomic variables when the government announces the news on a tariff decrement since the negotiation of FTA starts. With a small-open-economy DSGE model, we examine various cases that the outcome of negotiation is consistent with people’s expectation. The news may affect people’s behavior by changing their expectation. We focus on the short run effects, to analyze the period between announcement and implement. The results show that the news does not generate positive effect, but negative in the
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short run, because people tend to postpone their consumption and investment when the tariff reduction leads to lower import prices. The positive effect of tariff reduction will not occur until the tariff reduction is realized as expected. If the negotiation takes longer or the realized tariff reduction is smaller than expectation, the negative effect may last longer, followed by smaller or zero positive effects. The aggregate effects of tariff news in long run may affect the welfare.
To evaluate its effects on the welfare, this model can be extended into one which focuses on welfare comparison. Another interesting issue remains for the future research is to examine the tariff news in an extended three country model to take into account the effects of the free trade agreement between two countries on the third country which is not included.
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Table
Table 1: The implication of various realization of tariff news (We only discuss the situation of enter FTA, so t is always greater than zero)
Different combination of shocks Implications
t 0
t 0 Anticipated tariff adjustment
t 0
t 0 Expectation full realized
t 0
0t t Expectation partially realized
t 0
t t Expectation not realized at all
t 0
t 0 Adjustment more than expectation
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Table 2: Calibrated Parameter
Parameter Value Description
r 0.01 Capital return
1 1.01 Subjective discount factor
m 0.3 Share of import goods use in final goods production
d 1m Share of domestic goods use in final goods production
0.6 Price elasticities of aggregate import
0.6 Price elasticities of aggregate export
v 6 Price-marginal markup composition
0.75 Probability of price resetting
0.0019 Capital mobility
0.24 Technology parameter for labor share
0.025 Depreciation rate
15 Capital adjustment cost
X * 0.27 Export demand multiplier
0.17 Import tariff
* 0.17 Export tariff
e 1 Nominal exchange rate
A 0.9 Lasting degree of last period of TFP
A 0.01 Volatility of TFP
* 0.8 Lasting degree of last period of world price
* 0.005 Volatility of world price
i 0.75 Lasting degree of last period of world interest rate
i 0.004 Volatility of world interest rate Inflation 1 Price growth factor
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Figure
12Figure 1: Unanticipated tariff shock in period 4 (decrease by 0.05)
12 The figures of impose response function here are measure in the level deviation from the steady state. To see the percentage change, the number should be multiplied by 100.
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Figure 2: Anticipated tariff news shock (decrease 0.05 after 4 period)
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Figure 3: Anticipated tariff news shock (decrease 0.05 after 1 period)
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Figure 4: Anticipated tariff news shock (decrease 0.05 after 8 period)
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Figure 5: Anticipated tariff news shock (realize at one year postponed)
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Figure 6: Anticipated tariff news shock (unrealized)
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Figure 7: Anticipated tariff news shock lower expectation (news: decrease 0.05 after 4 period, real: 0.03)
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Appendix A: Value function
To let coding in dynare be possible, we have to transfer the form summation into the form of value. To associate with the conversion of real variables later, the computation combines both conversion of real variables and value function can refer as following
Multiplying both side with denominator, as substitute the t td, into original form
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Converting into real variables (dividing with P ) t
Setting the value function, we can rename LHS as value function m(.)and RHS asn(t),
of value functions
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Appendix B: Converting into real variables
First of all, we have to summarize our model, and we can solve 40 endogenous variables with 40 equations.
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Equations (11.-19.) are already in terms of real variables.
And for the conversion into real variables, we let
d
Equations in terms of real variables can be expressed as following
1. . 1
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Appendix C: Solving the steady state
In order describe the path of steady state, we have to obtain the initial value which we assume the economy is in steady state.
First, we assume
* * * * 1 *
1, , , d m x 1, f 1, 1, 0
q i i i A b b
,
as what we discuss in chapter 3.9.
Then we can derived the steady state as following 1. mc