DOI: doi.org/10.71734/DP-2026–10

This paper investigates the macroeconomic and welfare implications of various tariff scenarios, including unilateral tariffs, retaliatory measures, and sector-specific tariffs. The research is motivated by the resurgence of protectionist policies and their potential to disrupt global trade and economic dynamics. By employing a four-region dynamic general equilibrium (DGE) model with a multi-sectoral production network, we provide insights into the strategic interactions of tariff conflicts and their economic consequences. The findings thus underscore the importance of global production networks when analyzing the implications of trade conflicts.

Simulating trade conflicts with a dynamic production network model

The study uses a four-region DGE model representing the United States, China, the European Union (plus UK), and the rest of the world. The model incorporates six production sectors, ranging from food and beverages to manufacturing and services, and accounts for the interconnectedness of global supply chains. We simulate five scenarios: unilateral US tariffs on China, Chinese retaliation, coordinated US-EU tariffs on China, US tariffs on China and the EU, and reciprocal tariffs between the US and the EU. The model also explores the effects of sector-specific tariffs to understand how targeted measures influence economic outcomes.

Tariffs as a double-edged sword

Our analysis illustrates the dual effects of tariffs. On the one hand, tariffs can boost domestic production by making imported goods more expensive, thereby increasing demand for local products. On the other hand, they raise production costs by making imported intermediate goods more expensive. This can lead to higher producer prices and reduced global income. The study also highlights the strategic nature of tariffs: Targeted countries often have an incentive to retaliate, which amplifies the negative effects on global trade and welfare.

Key insights: short-term gains, long-term losses

The findings reveal that unilateral tariffs can temporarily boost domestic output and consumption in the imposing country by making local goods relatively cheaper. However, these benefits are short-lived. Over time, higher production costs and reduced global demand erode the initial gains. For instance, in a scenario where the US imposes unilateral tariffs on China, US output and consumption increase modestly in the short term. However, if China retaliates, these gains disappear, and both countries experience significant economic losses.

We also find that the European Union and the rest of the world suffer indirect losses due to reduced global demand, even if they are not directly involved in the tariff conflict. In scenarios with broad tariffs, global welfare declines across all regions, with the most severe losses occurring in a scenario of escalated trade conflicts between the US, EU, and China.

Strategic implications: a game of retaliation

The study underscores the strategic nature of tariff conflicts. While unilateral tariffs may initially benefit the imposing country, they are rarely stable, as targeted countries have strong incentives to retaliate. For example, Chinese retaliation against US tariffs brings slight benefits to China whilst also inflicting greater harm on the US economy. Similarly, the EU has little incentive to join a US-led coalition against China, as it faces significant welfare losses if China retaliates. The analysis suggests that tariff conflicts often escalate into "race-to-the-top" scenarios, where all parties are worse off.

Sector-specific tariffs: a more nuanced approach?

We further explore the effects of targeting specific sectors, such as electronics or motor vehicles, rather than imposing broad tariffs. We find that sector-specific tariffs can lead to more pronounced shifts in production and trade patterns. Interestingly, sector-specific tariffs reduce the incentive for retaliation in some cases.

Conclusion: the high cost of protectionism

Our research highlights the inefficiency of tariffs as a tool for economic protection. While they may offer temporary benefits, their long-term consequences are often detrimental, particularly in the face of likely retaliation. In addition, global welfare losses increase in step with the number of regions introducing tariffs.

Ernst, A., N. Hinterlang, M. Jäger, N. Stähler (2026), America first? The macroeconomic implications of punitive tariffs in a production network model, Bundesbank Discussion Paper, No 10/2026