TY  - JOUR
AU  - Engel,Charles
AU  - Kletzer,Kenneth
TI  - Trade Policy under Endogenous Credibility
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 2449
PY  - 1987
Y2  - November 1987
UR  - http://www.nber.org/papers/w2449
L1  - http://www.nber.org/papers/w2449.pdf
N1  - Author contact info:
Charles Engel
Department of Economics
University of Wisconsin
1180 Observatory Drive
Madison, WI  53706-1393
Tel: 608/262-3697
Fax: 608/262-2033
E-Mail: cengel@ssc.wisc.edu

Kenneth Kletzer
University of California, Santa Cruz
Department of Economics
217 Social Sciences 1
Santa Cruz, CA  95064
Tel: 408-459-3407
E-Mail: kkletzer@cats.ucsc.edu
AB  - 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.
ER  -