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

  • Fazio, Giorgio
  • MacDonald, Ronald
  • Melitz, Jacques

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 fundamental revision of Obstfeld and Rogoff’s argument. A further novelty of our work is in tying bilateral trade behaviour to desired aggregate trade balances and desired intertemporal trade.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 5137.

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Date of creation: Jul 2005
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Handle: RePEc:cpr:ceprdp:5137
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