Working Paper: CEPR ID: DP5137
Authors: Giorgio Fazio; Ronald Macdonald; Jacques Melitz
Abstract: 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.
Keywords: current account; feldstein-horioka puzzle; gravity model; home bias puzzle; trade balance; trade costs
JEL Codes: F10; F32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| trade costs (F19) | trade balances (F10) |
| trade costs (F19) | current accounts (F32) |
| trade balances (F10) | current accounts (F32) |