Working Paper: NBER ID: w21774
Authors: Jonathan Eaton; Samuel S. Kortum; Brent Neiman
Abstract: Obstfeld and Rogoff (2001) propose that trade frictions lie behind key puzzles in international macroeconomics. We take a dynamic multicountry model of international trade, production, and investment to data from 19 countries to assess this proposition quantitatively. Using the framework developed in Eaton, Kortum, Neiman, and Romalis (2016), we revisit the puzzles in a counterfactual world without trade frictions in manufactures. Removing these trade frictions goes a long way toward resolving a number of the puzzles: The dependence of domestic investment on domestic saving falls by half or disappears entirely, mitigating the Feldstein-Horioka (1980) puzzle. Changes in nominal GDPs in U.S. dollars become less variable across countries and line up with changes in real GDPs as much as with real exchange rates, mitigating the exchange rate disconnect puzzle. Less dramatically, changes in consumption become more correlated across countries, mitigating the consumption correlations puzzle and changes in real exchange rates become less variable across countries, mitigating the relative purchasing power parity puzzle.
Keywords: Trade Frictions; International Macroeconomics; Feldstein-Horioka Puzzle; Exchange Rate Disconnect
JEL Codes: E3; F17; F4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Removing trade frictions in manufactures (F13) | Dependence of domestic investment on domestic saving (E22) |
| Removing trade frictions in manufactures (F13) | Variability of nominal GDP across countries (O57) |
| Removing trade frictions in manufactures (F13) | Correlation of consumption across countries (F62) |