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Non-traded goods, factor markets frictions, and international capital flows

Author

Listed:
  • Jacek Rothert

    (United States Naval Academy
    Group for Research in Applied Economics (GRAPE))

  • Jacob M. Short

    (Bank of Canada)

Abstract

The canonical one-sector model over predicts international capital flows by a factor of ten. We show that introducing a non-traded goods sector can reconcile the differences between the theoretical predictions and the observed flows. We analyze the quantitative impact of the nontraded sector using a calibrated model of a small open economy, in which non-traded goods are used in consumption and investment, and need capital and labor to be produced. The model features international frictions directly affecting international borrowing and lending, as well as domestic frictions that limit the scope of inter-sectoral reallocation of capital and labor. We find that: (1) the impact of domestic frictions on the size of international capital flows is similar to the impact of international frictions, and (2) the median elasticity of capital flows with respect to international frictions in the two-sector model with costly inter-sectoral reallocation is about 50-60% lower than that same elasticity in the one-sector model.

Suggested Citation

  • Jacek Rothert & Jacob M. Short, 2021. "Non-traded goods, factor markets frictions, and international capital flows," GRAPE Working Papers 59, GRAPE Group for Research in Applied Economics.
  • Handle: RePEc:fme:wpaper:59
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    More about this item

    Keywords

    non-traded sector; capital flows; savings wedge; allocation puzzle;
    All these keywords.

    JEL classification:

    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F43 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Economic Growth of Open Economies
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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