Trade Policy under Endogenous Credibility

Charles Engel, Kenneth Kletzer

NBER Working Paper No. 2449
Issued in November 1987
NBER Program(s):International Trade and Investment, International Finance and Macroeconomics

Because trade liberalization which is anticipated to be temporary creates a divergence between the effective domestic rate of interest and the world rate of interest, tariff-reduction in the presence of international financial asset trade may reduce welfare for a small country. Calvo has argued that even though the government intends to liberalize trade permanently, if the private sector believes with some probability that a tariff will be imposed in the future, then free trade may not be optimal. This paper first formalizes this argument and discusses the optimal policy for a government which seeks to maximize representative household welfare. The government's lack of credibility is represented by a set of beliefs the private sector holds about the type of government it faces. Next, beliefs are endoqenized by allowing me private sector to update them using Bayes' rule. In one approach, the true government's objective is maximize welfare for the economy, so that it does not seek to imitate another type, in contrast with other recent models of policy credibility. With learning, the government eventually adopts free trade, even though restricted trade is optimal initially.

download in pdf format
   (391 K)

download in djvu format
   (281 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w2449

Published: Journal of Development Economics Volume 36, October 1991, 213-228 citation courtesy of

Users who downloaded this paper also downloaded* these:
Basu, Kimball, Mankiw, and Weil w3054 Optimal Advice for Monetary Policy
Hamermesh and Wolfe w1887 Compensating Wage Differentials and the Duration of Wage Loss
Aizenman w3600 Trade Reforms, Credibility, and Development
Rodrik w2600 Promises, Promises: Credible Policy Reform via Signaling
De Gregorio, Edwards, and Valdes w7645 Controls on Capital Inflows: Do they Work?
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us