• Tariffs and the US dollar: Economics was right, after all

Tariffs and the US dollar: Economics was right, after all

Tariffs and the US dollar: Economics was right, after all
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Open macro models predict that the impact of tariffs on a country’s domestic currency depends on how trade partners respond to such measures. This column explores the effects of tariffs announced or imposed by foreign countries on the US in response to measures threatened or imposed by President Trump – during both his first and second terms. In short, when tariffs are met with expected retaliation, the dollar weakens. The recent dollar depreciation has nonetheless been accompanied by a sustained increase in longer-term Treasury yields, reflecting market concerns about the fiscal and macroeconomic consequences of intensifying trade and geopolitical fragmentation.

The sharp depreciation of the US dollar (USD) following Donald Trump’s ‘Liberation Day’ tariff announcements on 2 April 2025 appeared to mark a break from past patterns. The USD weakened significantly, both against the euro and in effective terms across a basket of currencies (see upper panel of Figure 1). Coupled with a spike in US Treasury bond yields, these moves have been interpreted as a ‘reserve-currency shock’ – a shift in investor perceptions about the safety premium traditionally associated with American assets and the USD.

Figure 1

Figure 1

Source: Ostry et al. (2025)

Still, many observers have argued that this reaction contradicts standard economic theory. After all, shouldn’t a country imposing tariffs see its currency appreciate due to a shift in global demand toward domestic goods? Doesn’t this disprove the reliability of economic models? Not exactly. As discussed in earlier work (Bergin and Corsetti, 2023; 2025), the standard open-economy model makes precise predictions: the USD’s reaction to tariffs depends crucially on whether those tariffs are unilateral or met with retaliation. The USD tends to appreciate when the White House imposes tariffs unilaterally but depreciates when foreign countries retaliate. This result emerges from the combined effects of trade policy and optimal monetary stabilisation – both in the United States and abroad.

This theoretical insight is backed by empirical evidence.

Theory meets data

Together with Daniel Ostry (who led the project) and Simon Lloyd, we tested the theoretical predictions laid out above using data from the first Trump administration and the more recent 2025 period (Ostry et al., 2025).

Our main question: do tariffs necessarily lead to a stronger currency? Relative to existing literature, our innovation lies in distinguishing between tariff shocks that do and do not trigger retaliation.

A clear illustration comes from the 1 March 2018 announcement of US tariffs on steel and aluminum imports from the European Union (EU). The media quickly anticipated a retaliatory response. For example, the Financial Times headline on 2 March 2018 read: “EU considers imposing `safeguard’ import tariffs in response to US”. As expected, the EU formally announced retaliatory measures on 7 March. As seen in the lower panel of Figure 1, the USD weakened immediately after the US announcement and remained lower throughout March, even after the EU response.

Our econometric analysis confirms that this pattern is systematic. The key takeaway is that US tariff announcements are not inherently associated with a stronger USD. In fact, depreciation is common when markets anticipate foreign retaliation.

A novel dataset

To carry out our study, we constructed a novel database of US tariff announcements, threats and implementations from 2018-2020 and, for comparison, from 2025. This also includes corresponding responses from the EU, China and Canada. We relied on detailed event timelines compiled by the Peterson Institute for International Economics, supplemented with real-time news coverage.

We classified events at daily frequency as either (i) tariff announcements/threats or (ii) tariff implementations. Each event is treated as a ‘shock’ – containing information largely unanticipated by markets, in terms of tariff rate, sector and coverage. A US tariff shock is labeled as retaliated against if another country threatens or imposes a tariff within seven days (we test the robustness of this definition).

The resulting dataset includes 45 US and 21 foreign tariff events from 2018-2020, and 13 US and ten foreign events from 2025. We quantify the economic size of each action using an ‘effective tariff-rate shock’ – a weighted average combining ad valorem tariff rates and import shares. This captures the economic relevance of each event.

The tariff events in our dataset are illustrated in Figure 2 which plots effective US tariff shocks from 2018-2020. The upper panel presents US tariff shocks, the bottom panel plots foreign ones. In the upper panel, orange circles represent tariffs that targeted China, black squares denote tariffs aimed at other countries. Filled markers indicate actions that were retaliated against. For instance, the first filled black square on the left marks the 1 March 2018 steel/aluminum announcement. The calculated shock is about 0.3%, accounting for the 25% and 10% tariffs on steel and aluminum, respectively, and their share in total imports. Overall, US tariff shocks range from -1% to +2%, with negative values reflecting paused, canceled or reversed tariffs.

Figure 2

Figure 2

Source: Ostry et al. (2025)

The lower panel shows tariff shocks from foreign responses. Shaded markers indicate retaliation. While foreign retaliation tends to occur quickly, their magnitudes are generally modest – ranging from -0.1% to 0.5%, compared with the US range of -1% to 2%.

The response of the USD differs if tariff threats are met by retaliatory measures.

Armed with our dataset for the 2018-2020 period, we use local projections to estimate how the dollar and other variables respond over time to US tariff shocks. Figure 3 presents the key results.

Figure 3

Figure 3

Source: Ostry et al. (2025)

The left-hand panels show the response of effective USD and CNY exchange rates (where an increase denotes appreciation). The right-hand panels display the CNH/USD bilateral exchange rate (where an increase implies USD appreciation).

In the absence of retaliation (top panels), US tariff actions are associated with USD appreciation and CNY depreciation. A one percentage point tariff shock leads to about 1% USD appreciation over four weeks, on average.

But in the presence of retaliation (see bottom panels of Figure 3), the initial appreciation of the USD is fully reversed. Importantly, broader retaliatory responses – not just those limited to US-China trade – lead to even more pronounced USD depreciation. This is further illustrated in Figure 4, where we re-estimate our model focusing on a subset of 14 events involving US tariffs on other major trade partners (primarily the EU, Canada and Mexico), often in addition to measures levied on China.

To summarise, in Figure 3 the estimated effects of US tariffs and retaliatory tariffs are roughly symmetric in magnitude. This suggests that in a ‘tit-for-tat’ scenario, the USD exchange rate may remain broadly unchanged, as the upward and downward pressures offset each other.

In contrast, Figure 4 shows that the effects of retaliation are considerably stronger in this broader sample. The peak marginal effect of a one percentage point increase in the effective US tariff rate (in the absence of retaliation) is about +1.5% on the USD effective exchange rate. But the marginal effect of retaliation peaks at nearly -6 percentage points.

Figure 4

Figure 4

Source: Ostry et al. (2025)

If the rest of the world retaliates in response to an American tariff hike, our results indicate that the US dollar will depreciate – both in broad effective terms and against the euro.

What is different in 2025?

Theory and evidence suggest that when a country initiates a trade war, prompting widespread expectations of retaliation, its currency may not strengthen. In this sense, the USD’s depreciation in April 2025 is not surprising.

But there are key differences between the earlier sample and 2025, particularly in the scale of the depreciation and its co-movement with other asset prices. To explore this, we extend our empirical model to study the response of US bond yields at different maturities

In both samples (2018-2020 and 2025), USD depreciation is accompanied by a decline in short-maturity Treasury yields. But only in 2025 do we observe a sharp rise in long-maturity yields.

Conclusion

The ‘Liberation Day’ USD depreciation is consistent with earlier findings: when tariff actions are met with expected retaliation, the dollar weakens. The decline in short-term yields is also in line with past episodes.

What is new, however, is the sustained rise in long-term Treasury yields – an unprecedented move in our dataset. This likely reflects deeper market concerns about the fiscal and macroeconomic consequences of intensifying trade and geopolitical fragmentation.

Author: Giancarlo Corsetti

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