Overshooting Adjustment to Tariff Protection

Abstract: The paper analyzes the effects of tariffs on savings, investment and the net foreign asset position of a small open overlapping generations economy. The gradual adjustment of production to tariffs on imported investment goods generates a gradually declining flow of disposable wage incomes. The main insight of the paper is that such a temporarily declining wage profile creates, in addition to the permanently operating savings incentives, a transitory life-cycle type savings motive for generations living early in the transition period. As the production sector converges to its long-run stationary position, wage profiles become flat again and the transitory savings motive vanishes. The transitory savings component may give rise to overshooting in total savings and net foreign assets in the early phase of adjustment. The paper identifies large foreign indebtedness due to weak permanent savings incentives as the main precondition for overshooting.;