Working Paper: CEPR ID: DP7177
Authors: Jean Imbs; Isabelle Mejean
Abstract: Estimates of the elasticity of substitution between domestic and foreign varieties are small in macroeconomic data, and substantially larger in disaggregated studies. This may be an artifact of heterogeneity. We use disaggregated multilateral trade data to structurally identify elasticities of substitution in US goods. We spell out a partial equilibrium model to aggregate them adequately at the country level. We compare aggregate elasticities that impose equality across sectors, to estimates allowing for heterogeneity. The former are similar in value to conventional macroeconomic estimates; but they are more than twice larger -up to 7- with heterogeneity. The parameter is central to calibrated models in most of international economics. We discuss the difference our corrected estimate makes in various areas of international economics, including the dynamics of external balances, the international transmission of shocks, international portfolio choice and optimal monetary policy.
Keywords: aggregation; calibration; global imbalances; international portfolio; international transmission; monetary policy; trade elasticities
JEL Codes: F21; F32; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| conventional estimates of elasticity derived from aggregated data (C51) | significantly lower than corrected estimates derived from disaggregated data (C80) |
| corrected estimates accounting for sectoral heterogeneity (C51) | can exceed 6 or 7 (C39) |
| aggregation bias (C43) | lower elasticity estimates (C51) |
| accounting for differences across sectors (E01) | elasticity of substitution is substantially higher (D11) |
| correction for sectoral heterogeneity (C21) | crucial for calibrating international economic models (F40) |
| ignoring sectoral heterogeneity (F12) | leads to biased estimates (C51) |
| aggregation of elasticities must consider heterogeneity across sectors (C43) | influences predictions regarding external balances (F32) |
| aggregation of elasticities must consider heterogeneity across sectors (C43) | influences predictions regarding international shock transmission (F37) |
| aggregation of elasticities must consider heterogeneity across sectors (C43) | influences predictions regarding optimal monetary policy (E47) |