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Trade Costs, Market Integration, and Macroeconomic Volatility

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Author Info
Kanda Naknoi
Allan D. Brunner

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

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Length: 48 pages
Date of creation: 04 Apr 2003
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Handle: RePEc:imf:imfwpa:03/54

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Keywords: Trade ; Tariffs ; Exchange rates ; Globalization ;

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Jaewoo Lee & Menzie D. Chinn, 1998. "The Current Account and the Real Exchange Rate: A Structural VAR Analysis of Major Currencies," NBER Working Papers 6495, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. 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. [Downloadable!] (restricted)
  3. Clarida, Richard & Gali, Jordi, 1994. "Sources of real exchange-rate fluctuations: How important are nominal shocks?," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 41(1), pages 1-56, December. [Downloadable!] (restricted)
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  4. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers 1131, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  5. Eswar Prasad, 1999. "International Trade and the Business Cycle," IMF Working Papers 99/56, International Monetary Fund.
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  6. Engel, Charles & Rogers, John H, 1996. "How Wide Is the Border?," American Economic Review, American Economic Association, vol. 86(5), pages 1112-25, December. [Downloadable!] (restricted)
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  7. Jeffrey D. Sachs & Andrew Warner, 1995. "Economic Reform and the Process of Global Integration," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 26(1995-1), pages 1-118. [Downloadable!]
  8. Crucini, Mario J, 1997. "Country Size and Economic Fluctuations," Review of International Economics, Blackwell Publishing, vol. 5(2), pages 204-20, May.
  9. Uhlig, H., 1995. "A toolkit for analyzing nonlinear dynamic stochastic models easily," Discussion Paper 97, Tilburg University, Center for Economic Research. [Downloadable!]
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  10. 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. [Downloadable!] (restricted)
  11. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June. [Downloadable!] (restricted)
  12. 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. [Downloadable!] (restricted)
  13. 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. [Downloadable!] (restricted)
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  14. Alan C. Stockman & Linda L. Tesar, 1995. "Tastes and Technology in a Two-Country Model of the Business Cycle: Explaining International Comovements," NBER Working Papers 3566, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Dornbusch, Rudiger, 1987. "Exchange Rates and Prices," American Economic Review, American Economic Association, vol. 77(1), pages 93-106, March.
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  16. 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. [Downloadable!] (restricted)
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  17. Lane, Philip R., 1997. "Inflation in open economies," Journal of International Economics, Elsevier, vol. 42(3-4), pages 327-347, May. [Downloadable!] (restricted)
  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. [Downloadable!] (restricted)
  19. Senay, Ozge, 1998. "The Effects of Goods and Financial Market Integration on Macroeconomic Volatility," The Manchester School of Economic & Social Studies, Blackwell Publishing, vol. 66(0), pages 39-61, Supplemen.
  20. Sutherland, Alan, 1996. " Financial Market Integration and Macroeconomic Volatility," Scandinavian Journal of Economics, Blackwell Publishing, vol. 98(4), pages 521-39, December.
  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. [Downloadable!] (restricted)
  22. 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. [Downloadable!] (restricted)
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  23. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Novy, Dennis, 2006. "Trade Costs and the Open Macroeconomy," The Warwick Economics Research Paper Series (TWERPS) 778, University of Warwick, Department of Economics. [Downloadable!]
  2. Causa, Orsetta & Cohen, Daniel, 2006. "Industrial Productivity in 51 Countries, Rich and Poor," CEPR Discussion Papers 5549, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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