Tariffs and Trade Deficits

We develop a dynamic multi-country Ricardian trade model with aggregate uncertainty, where trade imbalances emerge as countries exchange goods and assets. We introduce a method for computing counterfactuals in this setting, which doesn’t require specifying the stochastic process of shocks or solving for asset prices. Applying the model to tariff shocks, we quantify their effects on prices, income, spending, and trade imbalances. We find that higher U.S. tariffs reduce the U.S. trade deficit through general equilibrium adjustments, but raise domestic prices and lower real consumption. Our findings highlight that movements in trade imbalances are shaped by the structure of global trade and finance, and that attempts to influence external balances through changes in trade barriers carry significant implications for real economic outcomes.