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

  • Giorgio Fazio
  • Ronald MacDonald
  • Jacques Melitz

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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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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