Domestic Demand or Trade Retaliation? China's Policy Responses to U.S. Tariff Hikes

ABSTRACT

Rising deglobalization has increased external uncertainty for the global economy. This paper develops a China–US Trade Equilibrium (CUTE) model that integrates monetary mechanisms and Hicksian welfare decomposition to examine the effects of U.S. tariff hikes on China and the U.S., as well as China's policy responses. A key contribution is the comparison of policy responses under identical policy costs. The results show that the direct macroeconomic impact of U.S. tariffs on China is modest, reflecting limited trade exposure and strong substitution effects, while broad tariffs generate larger welfare losses for the America through price increases and real income erosion. The reaction directly supporting household income and consumption yield substantially higher welfare returns than trade retaliation, government spending or monetary easing, as tariffs reduce real purchasing power. We suggest within the institutional settings considered, prioritizing household‐based demand support is a more effective response to external tariff shocks than retaliatory trade measures.