The tariffs initiated by President Donald Trump on April 2 have significantly impacted the global economy, creating waves across financial markets that were not entirely anticipated.
Economists are taking a deeper look into these developments, particularly in light of research by Oleg Itskhoki, a professor of economics, and his colleague Dmitry Mukhin from the London School of Economics.
Their work in a new working paper introduces the concept of the ‘optimal macro tariff,’ which refers to an import tax rate that best serves U.S. economic interests.
Historically, the discussion around tariffs has often focused on trade balances, but Itskhoki and Mukhin emphasize the interconnectedness of trade and financial markets in this new era.
In the wake of the 1930s, a period characterized by extensive protectionism due to the Great Depression, the conversation around tariffs has been evolving.
This erosion of a globalized tariff-free trading environment marks a stark contrast to the aftermath of the Great Financial Crisis of 2008, which did not see a rise in protectionist sentiment despite the economic turmoil.
In today’s landscape, the U.S. continues to grapple with its position in a global economy marked by persistent trade imbalances and a reliance on foreign investments.
According to Itskhoki, while many countries have experienced trade deficits, the U.S. stands out due to its significant ownership of high-risk foreign assets.
Such assets traditionally yield higher returns compared to liabilities such as U.S. Treasuries.
Previously, the federal government benefited from low interest rates, bolstering its capacity to support a trade deficit without apparent immediate repercussions.
However, rising interest rates have strained this situation as the U.S. government faces increased borrowing costs, leading to a fiscal deficit that dwarfs the already existing trade deficit.
The introduction of tariffs complicates this fiscal scenario.
The response to these tariffs typically leads to a strengthened dollar as American consumers reduce their imports.
With the reduced demand for foreign currencies, the dollar appreciates, causing American exports to become more expensive and thereby reducing global demand for U.S. goods.
This dynamic produces a new equilibrium characterized by diminished trade activity on both ends.
The effect of such currency shifts — often referred to as ‘valuation effects’ — can be perceived as financial transfers, adversely affecting the US economy while benefiting foreign holders of U.S. assets.
Consequently, the optimal tariff measurable by traditional standards is smaller within today’s interconnected financial system.
A range of 25 to 35 percent was identified as the optimum rate if one disregards potential retaliatory measures from other countries.
However, factoring in the complex realities of global finance brings this number down to approximately 9 percent, reflecting the delicate balance required to maintain engaged trade relations.
Furthermore, Itskhoki argues that governments need to differentiate between adopting tariffs and offering direct subsidies to stimulate employment in tradable sectors.
Tariffs, fundamentally a trade tax, can inadvertently contract the tradable sector, with adverse consequences for both exports and imports, potentially undermining manufacturing employment amid ongoing trade disputes.
The lessons distilled from this research call for a nuanced approach to policy, encouraging careful consideration and a democratic process regarding which sectors to subsidize, especially in light of the fiscal constraints at play.
The evolving economic landscape indicates that while the U.S. may collect tariff revenues in the short term, a broader strategic vision is necessary to avoid adverse long-term consequences stemming from a loss of faith in the U.S. dollar and its central role in global finance.
As Itskhoki emphasizes, addressing tariffs and global interdependencies are core to formulating effective economic policies moving forward.
image source from：https://news.harvard.edu/gazette/story/2025/06/how-market-reactions-to-recent-u-s-tariffs-hint-at-start-of-global-shift-for-nation/
