by Charles Engel and Akito Matsumoto

http://d.repec.org/n?u=RePEc:imf:imfwpa:09/138&r=opm

Well-known empirical puzzles in international macroeconomics concern the large divergence of equilibrium outcomes for consumption across countries from the predictions of models with full risk sharing. It is commonly believed that these risk-sharing puzzles are related to another empirical puzzle-the home-bias in equity puzzle. However, we show in a series of dynamic models that the full risk sharing equilibrium may not require much diversification of equity portfolios when there is price stickiness of the degree typically calibrated in macroeconomic models. This conclusion holds under a range of assumptions about home bias in preferences, price setting as PCP or LCP, and with or without nominal wage stickiness as long as there is some price rigidity.

The authors show that Cole and Obstfeld (1991) result that terms of trade adjustments provide for the majority of the risk-sharing benefits is only true when prices are flexible. In a log-linearized version of a two-country DSGE model with sticky prices, trade in only equities achieves complete risk sharing. For many parametrizations, households are long on home equity and short on foreign equity, so that an unexpected currency depreciation which has positive income effects under sticky prices is offset by a negative wealth shock to the portfolio. As with the results of, e.g., Devereux and Sutherland (2008), it may be interesting to see the implications of inefficient portfolio selection due to imperfect information, uncertainty, etc.

by Gita Gopinath, Pierre-Olivier Gourinchas, Chang-Tai Hsieh, Nicholas Li

http://d.repec.org/n?u=RePEc:fip:fedbwp:09-10&r=opm

To what extent do national borders and national currencies impose costs that segment markets across countries? To answer this question the authors use a dataset with product-level retail prices and wholesale costs for a large grocery chain with stores in the United States and Canada. They develop a model of pricing by location and employ a regression discontinuity approach to estimate and interpret the border effect. They report three main facts: One, the median absolute retail price and wholesale cost discontinuities between adjacent stores on either side of the U.S.-Canadian border are as high as 21 percent. In contrast, within-country border discontinuity is close to 0 percent. Two, the variation in the retail price gap at the border is almost entirely driven by variation in wholesale costs, not by variation in markups. Three, the border gaps in prices and costs co-move almost one-to-one with changes in the U.S.-Canadian nominal exchange rate. They show these facts suggest that the price gaps they estimate provide only a lower bound on border costs.

The authors build a two-country model of horizontal differentiation based on Salop’s (1979) circular city model in which degree of segmentation is endogenous and depends on the sizes of countries, distance from the border and substitutability across locations. The model itself provides numerous novel predictions and can account for a number of properties of prices across borders. The authors then discontinuity regression approach on a scanner price dataset of a large US & Canadian retailer to document how the model can match several interesting properties of prices across borders. A very interesting contribution.

by Kristian Behrens and Yasusada Murata

http://d.repec.org/n?u=RePEc:lvl:lacicr:0928&r=opm

We analyze the impact of globalization on individual gains from trade in a general equilibrium model of  monopolistic competition featuring product diversity, procompetitive effects and income heterogeneity between and within countries. We show that, although trade reduces markups in both countries, its impact on variety depends on their relative position in the world income distribution: product diversity in the lower income country always expands, while that in the higher income country may shrink. When the latter occurs, the richer consumers in the higher income country may lose from trade because the relative importance of variety versus quantity increases with income. We illustrate this effect using data on GDP per capita and population for 186 countries, as well as parameter estimates for domestic income distributions. Our results suggest that U.S. trade with countries of similar GDP per capita makes all agents in both countries better off, whereas trade with countries having lower GDP per capita may adversely affect up to 11% of the U.S. population.

In a framework that allows decomposition of gains from trade into those due to product diversity and due to pro-competition effects, Behrens and Murata show that product diversity always expands with trade in poor countries (may shrink in rich countries), and that trade always improves competition. Consequently, everyone in poor countries must gain, while there may be situations when some rich citizens of rich countries lose from trade because they value loss of diversity more than gain in efficiency.

It would be interesting to see how the results change if comparative advantage and two productive factors are introduced into the model’s framework. It would also be interesting to get a sense of the extent to which assumed variable elasticity of substitution (with income) is an empirically relevant modeling strategy.

This blog is an experiment to explore the feasibility of scientific discussion on an Economics blog. NEP-OPM disseminates every week new working papers in the field of Open Macroeconomics. Among them, the NEP-OPM editor selects one to be discussed. Everyone is invited to comment. Try to stay civil, or your comments will be removed. And encourage others to read or join in the discussion.