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Trade Costs, Trade Balances and Current Accounts: An Application of Gravity to Multilateral Trade

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  • Giorgio Fazio
  • Ronald MacDonald
  • Jacques Melitz

Abstract

In this paper we test the well-known hypothesis of Obstfeld and Rogoff (2000) that trade costs are the key to explaining the so-called Feldstein-Horioka puzzle. Using a gravity framework in an intertemporal context, we provide strong support for the hypothesis and we reconcile our results with the so-called home bias puzzle. Interestingly, this requires a fundamental revision of Obstfeld and Rogoff’s argument. A further novelty of our work is in tying bilateral trade behavior to desired aggregate trade balances and desired intertemporal trade.

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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 1529.

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Date of creation: 2005
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Handle: RePEc:ces:ceswps:_1529

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Keywords: Feldstein-Horioka puzzle; trade costs; gravity model; home bias puzzle; current account; trade balance;

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References

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  1. Paul R. Bergin & Reuven Glick, 2003. "Endogenous Tradability and Macroeconomic Implications," NBER Working Papers 9739, National Bureau of Economic Research, Inc.
  2. Bergstrand, Jeffrey H, 1989. "The Generalized Gravity Equation, Monopolistic Competition, and the Factor-Proportions Theory in International Trade," The Review of Economics and Statistics, MIT Press, vol. 71(1), pages 143-53, February.
  3. Jacques Melitz, 2003. "Language and Foreign Trade," Working Papers, Centre de Recherche en Economie et Statistique 2003-26, Centre de Recherche en Economie et Statistique.
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  7. Philip R. Lane & Gian Maria Milesi-Ferretti, 2001. "External Wealth, the Trade Balance, and the Real Exchange Rate," Trinity Economics Papers, Trinity College Dublin, Department of Economics 200121, Trinity College Dublin, Department of Economics.
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  23. Cochrane, John H, 1988. "How Big Is the Random Walk in GNP?," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(5), pages 893-920, October.
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  25. Michael Dooley & Jeffrey Frankel & Donald J. Mathieson, 1987. "International Capital Mobility: What Do Saving-Investment Correlations Tell Us?," IMF Staff Papers, Palgrave Macmillan, vol. 34(3), pages 503-530, September.
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Citations

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Cited by:
  1. Cardamone, Paola, 2007. "A survey of the assessments of the effectiveness of Preferential Trade Agreements using gravity models," Working Papers, TRADEAG - Agricultural Trade Agreements 7282, TRADEAG - Agricultural Trade Agreements.
  2. Bertrand BLANCHETON (CMHE-IFReDE-GRES) & Samuel MAVEYRAUD-TRICOIRE (Université Bordeaux IV), 2006. "The indicators of international financial integration: A set of convergent measures (In French)," Cahiers du GRES, Groupement de Recherches Economiques et Sociales 2006-13, Groupement de Recherches Economiques et Sociales.
  3. Konrad, Kai A & Skaperdas, Stergios, 1999. "The Market for Protection and the Origin of the State," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2173, C.E.P.R. Discussion Papers.
  4. Cipollina, Maria & Salvatici, Luca, 2007. "Reciprocal trade agreements in gravity models: a meta-analysis," Economics & Statistics Discussion Papers esdp07035, University of Molise, Dept. EGSeI.
  5. N. Holinski & C.J.M. Kool & J. Muysken, 2011. "The Impact of International Portfolio Composition on Consumption Risk Sharing," Working Papers, Utrecht School of Economics 11-20, Utrecht School of Economics.
  6. Apergis, Nicholas & Tsoumas, Chris, 2009. "A survey of the Feldstein-Horioka puzzle: What has been done and where we stand," Research in Economics, Elsevier, Elsevier, vol. 63(2), pages 64-76, June.
  7. Luke Willard, 2007. "Trade Costs and Some Puzzles in International Macroeconomics," RBA Research Discussion Papers, Reserve Bank of Australia rdp2007-10, Reserve Bank of Australia.
  8. Martin Schmitz, 2014. "Financial remoteness and the net external position," Review of World Economics (Weltwirtschaftliches Archiv), Springer, Springer, vol. 150(1), pages 191-219, February.

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