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The Dynamics of the Trade Balance and the Real Exchange Rate: The J Curve and Trade Costs?

Author

Listed:
  • Horag Choi

    (Monash University)

  • George Alessandria

    (University of Rochester)

Abstract

We show that flexible and sticky price multi-country models generate a counterfactual comovement between the trade balance and the real exchange rate and that the dynamics of the US trade balance since 1980 are mostly attributed to declines in trade costs and a gradual response of trade flows to past movements in the real exchange rate. We develop a theoretical model with heterogenous producers, a dynamic export participation decision, pricing to market, and declining trade costs to address these properties of the trade balance. With temporary and permanent shocks to trade costs leading to fluctuations in trade and the observed increases in trade, the model can capture the dynamics of the trade balance and the real exchange rate. With these movements in the trade balance, business cycles are substantially more synchronized and there is much less consumption risk sharing.

Suggested Citation

  • Horag Choi & George Alessandria, 2015. "The Dynamics of the Trade Balance and the Real Exchange Rate: The J Curve and Trade Costs?," 2015 Meeting Papers 1413, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:1413
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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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