Tariff Policy and Quantity Expectations in an Economy with Classical Unemployment

Tariff Policy and Quantity Expectations in an Economy with Classical Unemployment

An intertemporal two-sector, fix-price model for an open economy by taking account of future quantity expectations on either goods or labor markets is developed. Exportables prices are set by firms, while importables prices are given in the world markets. It is shown that the classical unemployment might come out under different exchange rate regimes as long as the importables firms pessimistically expect that sales constraints will be binding. Moreover, given that the economy is under the classical unemployment, a reduction in the tariff rate combined with a reduction in the government transfer payments might raise national income and make the trade balance deteriorate less sharply in the flexible exchange rate regime under some conditions. The policy implication is that to pursue the trade liberalization policy an economy might also need to consider to allow the exchange rate to adjust flexibly.