The National Bank of Georgia continues to publish research papers with the aim of improving analytical communication.

The latest working paper, "The Art of Trade War – A Stackelberg-Cournot Model of International Tariff Rivalry," prepared by the staff of the Macroeconomics and Statistics Department, aims to evaluate optimal tariff policy decisions by large economies.

The paper develops a three-player Stackelberg-Cournot model to analyze strategic decisions regarding international tariff policy. In the tariff-setting process, one country acts as a leader, followed by simultaneous tariff responses from the other two players. Ultimately, firms make decisions on the quantity of goods to supply to destination markets. The model incorporates heterogeneous market sizes, the distribution of tariff burdens between consumers and producers, bilateral trade preferences, as well as empirically estimated parameters reflecting demand and costs. Scenarios based on data from the US, China, and the EU show that despite increased local prices and reduced consumer surplus, leadership allows the first mover to secure short-term welfare gains through tariff revenues and the protection of local producers. These gains are obtained at the expense of trading partners, which ultimately leads to a reduction in global welfare and trade volumes.

The paper also shows that deviations from optimal tariff policies increase the gains of individual players, although global social welfare continues to decline. The results reveal that individual tariff decisions, which are rational for the players, create a Nash equilibrium but increase welfare losses. The research highlights the importance of cooperation in implementing tariff policy, as the decisions of large economies impact small open economies that are indirectly exposed to trade conflicts between major powers.

The goal of the NBG Working Paper Series is to contribute to the study of topics important to central banks and the economics profession. The series is circulated to facilitate discussion on the topics covered and to elicit feedback. The series is coordinated by the Macroeconomic Research Division of the National Bank of Georgia and focuses on topics relevant to central banks, such as macroeconomic modeling, monetary and exchange rate policies, financial stability, and others.