Protectionism and the Effective Lower Bound in the Euro Area

Abstract

This paper evaluates the macroeconomic impact on the euro area (EA) of the imposition of tariffs by simulating a multi-country New Keynesian model featuring the effective lower bound (ELB) on the EA monetary policy rate. The main results are as follows. First, the bilateral tariff dispute between the United States (US) and China (CH) has positive spillovers on the EA economy, because of favorable trade diversion effects. Second, simultaneous tariff increases between the US and CH and between the US and EA have negative effects on euro-area GDP and (ex-tariff) inflation. The effects are magnified if the ELB binds in the EA. Third, if the elasticity of substitution among tradables is low, the spillovers on euro-area GDP of US-CH trade tensions are negligible if the ELB is not binding, while they become negative if the ELB binds.