2 Six major puzzles in international macroeconomics: search for a common cause Obsteld M. and K. Rogoff, The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?, 2000, NBER Working paper 7777.Home bias in tradeSaving-investment puzzleEquity home biasConsumption correlation puzzlePurchasing Power ParityExchange rate disconnect
3 By explicitly introducing trade costs, one can go far toward explaining a great number of the main empirical puzzles. Trade costs may include transportation costs, tariffs, non-tariff barriers
4 Home bias in tradeInternational markets are more segmented then is commonly supposedThere is a substantial border effect that reduce cross-country tradeHow big is the border effect? Can the market segmentation be explained by trade costs of the reasonable size?
5 How big is the border effect? McCallum 1996, National Borders Matter: Canada-US regional trade patterns, American Economic Review 85, pp
7 Trade across individual Canadian provinces was 22 times higher then between individual Canadian provinces and US states!
8 Is anything wrong with McCallum’s estimation of the border effect Asymmetric effect on countries of different sizeMisspecification of the gravity equationAnderson and Wincoop (2003), Gravities with Gravitas: A solution to the Border puzzle, American Economic Review 93, ppNational borders reduce trade between the US and Canada by about 44%, while reducing trade among other industrialized countries by about 30%. McCallum's spectacular headline number is the result of a combination of omitted variables bias and the small size of the Canadian economy. Within-Canada trade rises by a factor 6 due to the border. In contrast, within-US trade rises 25%.
9 Asymmetric effect on countries of different size: numerical example With no trade barriers, Canada exports 90% of GDP to the US and sells 10% internallySuppose the border effect reduces cross-border trade by 50%Then, Canada imports 45% of GDP to US and trade 55% internallySo, internal trade went up by 5.5 times, cross border trade went down by 50%, and so internal trade has increased by 11 times more then cross-border tradeFor US, it used to import 10% of GDP and now imports 5%. Cross-state trade has increased by 2.1 times more then cross-border trade
10 Home bias in trade Obstfeld, Rogoff 2000: Average size trade costs combined with high elasticities of substitution of home for foreign goods can account for large part of home biasIn addition, exchange rate uncertainty and difference in tastes across countries also leads to higher home good consumption
12 Empirical estimates of θ Trefler and Lai (1999) θ=5.2panel of 28 industries in 36 countries for the periodCheung, Finn, and Fujji (1999): θ=3.5-4monopolistic competition modeltwo-digit industry level data for OECD countriesHummels (1999a): θ=5.6
16 Saving-investment puzzle Feldstein, Martin, and Charles Horioka (1980) “Domestic Savings and International Capital Flows,” Economic Journal 90 (358) June,Correlation between savings and investments in OECD countries is much greater then predicted by economic models
18 Equity home biasEquity home bias (Kenneth R. French; James M. Poterba, (1991), Investor Diversification and International Equity Markets The American Economic Review, Vol. 81, No. 2.)Economic agents prefer to keep their wealth in home assets. They diversify their portfolio less then predicted by models of risk-sharing and are overly optimistic about returns on home assetsAt the end of the 80th, Americans held 94 percent of their wealth in the US stock market, whereas Japanese held 98 percent of their equity wealth at home
20 Consumption correlation puzzle Consumption correlation puzzle (Backus, Kehoe, and Kydland 1992, International Real Business Cycles, Journal of Political Economy 100, pp )International output growth rates are more highly correlated then consumption growth rates
21 Purchasing Power Parity Purchasing Power Parity (Rogoff, Kenneth (1996), “The Purchasing Power Parity Puzzle,” Journal of Economic Literature, Vol.34, No. 2., pp )Does not hold in a short run, there are some evidence that it holds over the long horizon
22 Exchange rate disconnect Exchange rate disconnect (Baxter, M and A. Stockman, 1989, Business Cycles and Exchange Rate regime: some international evidence, Journal on Monetary Economics, 23, pp )Weak connection between exchange rates and virtually any macroeconomic aggregates