Tari®s, Unemployment, and the Current Account: An Intertemporal Equilibrium Model¤

This paper integrates labor market search into a dynamic general equilibrium model to analyze the macroeconomic e®ects of a tari®. The search friction creates a wedge between the marginal product of labor and the product wage. With perfectly °exible prices and wages, the model captures the intuitive e®ect that a permanent increase in the tari® improves the country's terms of trade, which tends to reduce the product wage and stimulates labor demand. However, the tari® also increases the price of the consumption goods bundle and reduces the marginal utility of wealth measured by imports. This consumption bundle e®ect raises the reservation wage and the product wage. When the consumption smoothing motive is realistically strong, the consumption bundle e®ect of the tari® dominates the direct product wage e®ect, leading to lower employment in both the short run and long run. Thus, even with persistent unemployment, raising tari®s is not the means in which a government in a small open economy can succeed in increasing employment, short run or long run. The welfare e®ect of the tari® is also analyzed.