Mishkin (2016, p. 476) writes:
Barriers to free trade such as tariffs (taxes on imported goods) and quotas (restrictions on the quantity of foreign goods that can be imported) can affect the exchange rate. Suppose the United States increases its tariff or puts a lower quota on Japanese steel. These increases in trade barriers increase the demand for American steel, and the dollar tends to appreciate because American steel will still sell well even with a higher value of the dollar. Increasing trade barriers causes a country’s currency to appreciate in the long run.
I do not quite understand why this is so.
Here are two simple thought experiments where the US imposing trade barriers might cause the USD to depreciate:
- The US imposes a quota on the import of Japanese steel. However, US demand for Japanese steel is inelastic, so that the JPY required to buy the quota of Japanese steel is actually higher than before. Since demand for JPY rises, the USD depreciates.
- Say that soybeans are the only US export and foreigners want USD only to buy US soybeans. Say now that the US bans the export of soybeans. Then wouldn't demand for USD fall, so that the USD falls?