Working Paper: NBER ID: w8804
Authors: Aart Kraay; Jaume Ventura
Abstract: What are the effects of increased trade in goods and services on the trade balance? We study the effects of reducing transport costs in a Ricardian model with complete asset markets. Trade integration has three effects on the structure of the economy: a reduction in the home bias in consumption, an increase in the degree of international competition in goods markets, and a reduction in real exchange rate volatility. The reduction in the home bias increases the volatility of the trade balance regardless of the source of shocks. Except for the case where supply shocks lead to counter-cyclical trade balances, (i) the increase in international competition also increases the volatility of the trade balance; and (ii) the reduction in real exchange rate volatility increases the volatility of the trade balance if risk aversion is low but lowers it if risk aversion is high. The opposite applies when supply shocks lead to counter-cyclical trade balances. We calibrate the model to U.S. data and provide a quantitative assessment of the effects of increased trade in services on the trade balance.
Keywords: No keywords provided
JEL Codes: F15; F36; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| trade integration (F15) | volatility of the trade balance (F14) |
| supply shocks (E39) | volatility of the trade balance (F14) |
| demand shocks (E39) | volatility of the trade balance (F14) |
| trade integration (F15) | terms of trade movements (F14) |
| terms of trade movements (F14) | volatility of the trade balance (F14) |
| increased trade in services (F19) | volatility of the trade balance (F14) |
| trade integration (F15) | effects of supply shocks on the trade balance (F41) |
| trade integration (F15) | effects of demand shocks on the trade balance (F41) |