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Trade Costs, Market Integration, and Macroeconomic Volatility

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  • Kanda Naknoi
  • Allan D. Brunner

Abstract

This paper examines the effects of trade costs on macroeconomic volatility. We first construct a dynamic, two-country general equilibrium model, where the degree of market integration depends directly on trade costs (transport costs, tariffs, etc.). The model is a extension of Obstfeld and Rogoff (1995). Naturally, a reduction in trade costs leads to more market integration, as the relative price of foreign goods falls and households increase their consumption of imported goods. In addition, with more market integration, the model predicts that the variability of the real exchange rate should fall, while the variability of the trade balance should increase. Trade costs have ambiguous effects on the volatility of other macro variables, such as income and consumption. Finally, we present some empirical findings that provide mixed support for the model''s predictions.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 03/54.

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Length: 49
Date of creation: 01 Mar 2003
Date of revision:
Handle: RePEc:imf:imfwpa:03/54

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Keywords: Trade; Exchange rates; trade costs; exchange rate; transport costs; real exchange rate; aggregate demand; market integration; fiscal shock; imported goods; tariff rates; domestic shocks; tariff rate; equilibrium model; exchange rate variability; domestic consumption; trade deficit; elasticity of substitution; exchange rate volatility; domestic aggregate demand; exchange rate movements; open economy; domestic goods; nominal exchange rate; tariff barriers; real effective exchange rate; open economies; real exchange rate volatility; domestic demand; measure of trade; changes in trade; imperfect competition; effective exchange rate; exchange rate dynamics; volume of trade; exchange rate changes; political economy; exchange rate policy; real exchange rate movements; trade openness; trade patterns; domestic firms; increased openness; trade pattern; policy on exchange rates; exchange rate change; economic integration; trade protection; product differentiation; transport cost; trade barriers; factor price; multilateral trade; trading arrangements; world demand; trade liberalization; nominal exchange rates; regional trade; global trading; world trade; real exchange rates; global integration; economic cooperation; increased trade; home currency; pattern of trade; per capita income; non-tariff barriers; exchange rate determination; domestic prices; unit of labor; international trade; bilateral trade; terms of trade; national borders; low trade;

References

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  1. McCallum, John, 1995. "National Borders Matter: Canada-U.S. Regional Trade Patterns," American Economic Review, American Economic Association, vol. 85(3), pages 615-23, June.
  2. Jordi Galí & Richard Clarida, 1993. "Sources of real exchage rate fluctuations: How important are nominal shocks?," Economics Working Papers 66, Department of Economics and Business, Universitat Pompeu Fabra, revised Jan 1994.
  3. Prasad, Eswar S, 1999. "International Trade and the Business Cycle," Economic Journal, Royal Economic Society, vol. 109(458), pages 588-606, October.
  4. Dornbusch, Rudiger, 1987. "Exchange Rates and Prices," American Economic Review, American Economic Association, vol. 77(1), pages 93-106, March.
  5. Senay, Ozge, 1998. "The Effects of Goods and Financial Market Integration on Macroeconomic Volatility," The Manchester School of Economic & Social Studies, University of Manchester, vol. 66(0), pages 39-61, Supplemen.
  6. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  7. Sutherland, Alan, 1996. " Financial Market Integration and Macroeconomic Volatility," Scandinavian Journal of Economics, Wiley Blackwell, vol. 98(4), pages 521-39, December.
  8. Jonathan E. Haskel & Matthew J. Slaughter, 2000. "Have Falling Tariffs and Transportation Costs Raised U.S. Wage Inequality?," NBER Working Papers 7539, National Bureau of Economic Research, Inc.
  9. Charles Engel & John H. Rogers, 1994. "How Wide is the Border?," NBER Working Papers 4829, National Bureau of Economic Research, Inc.
  10. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1992. "International Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 745-75, August.
  11. Jeffrey Sachs & Andrew Warner, 1995. "Economic Reform and the Progress of Global Integration," Harvard Institute of Economic Research Working Papers 1733, Harvard - Institute of Economic Research.
  12. Lastrapes, William D, 1992. "Sources of Fluctuations in Real and Nominal Exchange Rates," The Review of Economics and Statistics, MIT Press, vol. 74(3), pages 530-39, August.
  13. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 624-60, June.
  14. Krugman, Paul, 1980. "Scale Economies, Product Differentiation, and the Pattern of Trade," American Economic Review, American Economic Association, vol. 70(5), pages 950-59, December.
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  16. Lee, J. & Chinn, M.D., 1998. "The Current Account and the Real Exchange Rate: A Structural VAR Analysis of Major Currencies," Papers 97-98-17, California Irvine - School of Social Sciences.
  17. Harald Uhlig, 1995. "A toolkit for analyzing nonlinear dynamic stochastic models easily," Discussion Paper / Institute for Empirical Macroeconomics 101, Federal Reserve Bank of Minneapolis.
  18. Baier, Scott L. & Bergstrand, Jeffrey H., 2001. "The growth of world trade: tariffs, transport costs, and income similarity," Journal of International Economics, Elsevier, vol. 53(1), pages 1-27, February.
  19. Eichenbaum, Martin & Evans, Charles L, 1995. "Some Empirical Evidence on the Effects of Shocks to Monetary Policy on Exchange Rates," The Quarterly Journal of Economics, MIT Press, vol. 110(4), pages 975-1009, November.
  20. Lane, Philip R., 1997. "Inflation in open economies," Journal of International Economics, Elsevier, vol. 42(3-4), pages 327-347, May.
  21. Irwin, Douglas A, 1996. "The United States in a New Global Economy? A Century's Perspective," American Economic Review, American Economic Association, vol. 86(2), pages 41-46, May.
  22. Ahmed, Shaghil & Ickes, Barry W. & Ping Wang & Byung Sam Yoo, 1993. "International Business Cycles," American Economic Review, American Economic Association, vol. 83(3), pages 335-59, June.
  23. Crucini, Mario J, 1997. "Country Size and Economic Fluctuations," Review of International Economics, Wiley Blackwell, vol. 5(2), pages 204-20, May.
  24. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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Citations

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Cited by:
  1. Dennis Novy, 2010. "Trade Costs and the Open Macroeconomy," Scandinavian Journal of Economics, Wiley Blackwell, vol. 112(3), pages 514-545, 09.
  2. Kanda Naknoi, 2005. "Real Exchange Rate Fluctuations and Endogenous Tradability," 2005 Meeting Papers 857, Society for Economic Dynamics.
  3. Causa, Orsetta & Cohen, Daniel, 2006. "Industrial Productivity in 51 Countries, Rich and Poor," CEPR Discussion Papers 5549, C.E.P.R. Discussion Papers.

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