The International Elasticity Puzzle in CGE Models: Analyzing Tariff Im pacts on Exporters
Abstract:
The oversimplification of export price shocks in CGE models encounters the International Elasticity Puzzle in tariff policy simulations. This puzzle manifests in three key discrepancies: (1) the distinct impacts of temporary versus permanent export price adjustments on export quantities; (2) the significantly smaller magnitude of ex change rate elasticity relative to tariff elasticity in export responses; (3) the inverse sign of real exchange rate elasticity compared to tariff elasticity. Among potential improvements to CGE models, accounting for the sys tem-wide effects of price adjustments on resource allocation and income distribution is crucial. The negative sign and minimal magnitude of real exchange rate elasticity compared to tariff elasticity imply that equating their elasticity parameters would lead to underestimation of tariff effects under their interaction. Given the extensive application of CGE models in cross-disciplinary policy simulations, resolving this elasticity paradox promises enhanced theoretical consistency and result accuracy for the models. One alternative approach cir cumvents temporary export price shocks by incorporating fixed exchange rates within a single-country static CGE framework. Simultaneously, factor markets are configured with short-run rigidity to reflect conditions consistent with a fixed exchange rate regime. A comparative analysis of this fixed-exchange-rate approach versus simulations using the Neoclassical closure reveals that the latter exhibit smaller macroeconomic and sectoral impacts. This finding aligns with the theoretical prediction regarding the underestimated tariff effects.
