Ebook International Trade in Durable Goods: Understanding Volatility, Cyclicality, and Elasticities
One of the most established empirical regularities in international real business cycle (IRBC) analysis is the counter-cyclical behavior of net exports. In contrast, the behavior of imports and exports themselves has been largely neglected in the literature. They are much more volatile than GDP and both are pro-cyclical, facts which are at odds with the predictions of standard models. The large drop in the volume of world trade in 2008-2009 has attracted ample notice. But the drop in international trade is generally consistent with the patterns of cyclical trade movements we have seen over the past 35 years. This data lead us to expect a large drop in the volume of trade when markets experience a steep recession, especially if it is expected to be prolonged. Inspired by the evidence that a large fraction of international trade is in durable goods, we propose a two-country two-sector model, in which durable goods are traded across countries. Simulation results show that our model can match the trade sector data much better than standard models.
We first document two empirical findings that are very robust across our 25-OECD-country data: 1. The standard deviations of real imports and exports are about two to three times as large as that of GDP. 2. Real imports and exports are pro-cyclical and also positively correlated with each other. We label the first finding “trade volatility”, and the second one “positive comovement”. We also confirm in our dataset the well-documented negative correlation between net exports and output.
In standard international business cycle models, imports and exports are far less volatile than in the data they are even less volatile than GDP. We demonstrate this in a variety of models, both real business cycle and sticky-price dynamic models. We emphasize that the issue is not resolved by building versions of the model with high real exchange rate volatility. Although a more volatile exchange rate helps to increase the volatility of imports and exports, it generates a negative correlation between imports and exports. This is at odds with the finding of “positive comovement”.
We propose a model in which countries primarily trade durable goods, inspired by the fact that a large portion of international trade is in durable goods. In OECD countries, trade in durable goods on average accounts for about 70% of imports and exports. The importance of capital goods in international trade has also been documented by Eaton and Kortum (2001). Boileau (1999) examines an IRBC model with trade in capital goods. That study finds that allowing direct trade in capital goods improves the model’s performance in matching the volatility of net exports and the terms of trade. Boileau’s model shares some characteristics of the one we examine. It does not include consumer durable goods, which are necessary to understand some aspects of the data. Moreover, Boileau (1999) does not examine the implications of his model for imports and exports individually, which is the focus of our study. Erceg, Guerrieri, and Gust (2008) also emphasize that trade in capital goods helps model to replicate trade volatility. They argue that trade balance adjustment may be triggered by investment shocks from either home or foreign country and such adjustment may not cause substantial real exchange rate fluctuations. Warner (1994) finds that global investment demand has been an important determinant of US exports since 1967. However, we find that a model with trade in capital goods but not consumer durables is inadequate. In order to match the volatility of the trade data, a large share of traded goods must be durable. But if we take all of those traded goods to be capital, then the model would require, for example, that the US obtains almost all capital goods from imports while simultaneously exporting large quantities of capital.
Our model goes further by including both capital and durable consumption goods in international trade. In our baseline two-country two-sector model, nondurable goods are nontraded. Durable consumption flows require both home and foreign durable goods varieties and capital goods are aggregated from home and foreign varieties of capital. Simulation results show that the benchmark model can successfully replicate “trade volatility” and “positive comovement”. In addition, net exports in our model are counter cyclical and as volatile as in the data. So our model can match the trade sector data much better than the standard models. This improvement is not at the cost of other desirable features of standard models. The aggregate variables such as output, consumption, investment and labor, can also match the data well.
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