Ebook International Trade and Macroeconomic Dynamics with Heterogeneous Firms
Formal models of international macroeconomic dynamics do not usually address or incorporate the determinants and evolution of trade patterns. The vast majority of such macroeconomic models take the pattern of international trade and the structure of markets for goods and factors of production as given. The determinants of such trade patterns are, in turn, analyzed within methodologically distinct models that are generally limited to comparisons of long-run positions or growth dynamics after changes in some determinants of trade. These models do not consider short- to medium-run business cycle dynamics and their effect on the pattern of trade over time. This separation between modern models of international macroeconomics and trade theory is somewhat unnatural. Modern international macroeconomics prides itself on its micro foundations. Yet, it neglects to analyze the effects of macro phenomena on its microeconomic underpinnings. Similarly, much of trade theory does not recognize the aggregate feedback effects of micro-level adjustments over time.
This paper contributes to bridging the gap between international macroeconomics and trade theory. We use Melitz’s [2003] model of trade with monopolistic competition and heterogeneous firms as the microeconomic underpinning of a two-country, dynamic, stochastic, general equilibrium (DSGE) model of international trade and macroeconomics. Firms face some initial uncertainty concerning their future productivity when making an irreversible investment to enter the domestic market. Postentry, firms produce with different productivity levels. In addition to the sunk entry cost, firms face both fixed and per-unit export costs. Forward-looking firms formulate entry and export decisions based on expectations of future market conditions.
Only a subset of relatively more productive firms export, while the remaining, less productive firms only serve their domestic market. This microeconomic structure endogenously determines the extent of the traded sector and the composition of consumption baskets in both countries. Exogenous shocks to aggregate productivity, or entry and trade costs induce firms to enter and exit both their domestic and export markets, thus altering the composition of consumption baskets across countries over time. This introduces a new and potentially important channel for the transmission of macroeconomic shocks and their propagation over time.
We first introduce this microeconomic structure in a flexible price model with no international trade in financial assets—and focus on the role of goods market dynamics. We show that the microeconomic features of our model have important consequences for macroeconomic variables. Macroeconomic dynamics, in turn, feed back into firm-level decisions, further altering the pattern of trade over time. Our model generates deviations from purchasing power parity (PPP) that would not exist absent our microeconomic structure with heterogeneous firms. It provides an endogenous, microfounded explanation for a Harrod-Balassa-Samuelson (HBS) effect: More productive economies, or less regulated ones (phenomena that affect all firms in the economy), exhibit higher average prices relative to their trading partners. We then show how, under fully flexible prices, deviations from PPP display substantial endogenous persistence in response to transitory aggregate shocks (for very plausible calibrated parameters). Since the micro-level adjustments we analyze occur within sectors, our model also explains how these deviations from PPP are manifested in sector-level prices—even for sectors considered “traded.”
Next, we extend our model to allow for international bond trading. In this setup, we show that permanently more productive economies, or less regulated ones, also run persistent foreign debt positions to finance the accelerated entry of firms into the relatively more favorable business environment. A stochastic exercise shows that the model matches several important moments of the U. S. and international business cycle quite well. In contrast to benchmark international real business cycle (RBC) models, our setup generates positive GDP correlation across countries; it does not automatically produce high correlation between relative consumption and the real exchange rate; and it substantially reduces the “consumption-output anomaly” associated with standard models.
Download
PDF Ebook International Trade and Macroeconomic Dynamics with Heterogeneous Firms
Posted in :
