Tariffs, the exchange rate, and location

This paper employs a new open economy macroeconomics model to examine the macroeconomic effects of a rise in one country's tariff rate leading to international relocation of firms. In such a model, both the real exchange rate and international relocation of firms offer the key to an understanding the impacts of the tariff policy. The main findings of our analysis are that (i) the imposition of a tariff by the home country always increases the relative home consumption, (ii) the imposition of the tariff results in appreciation of the home currency, (iii) the appreciation then decreases the relative real profits of firms located in the home country, and consequently firms relocate to the foreign country, (iv) an increase in the flexibility of relocation weakens the responses of both the relative consumption and the exchange rate to the imposition of the tariff.