A Model of Endogenous Nontradability and its Implications for the Current Account
Paul R. Bergin
University of California, Davis - Department of Economics; National Bureau of Economic Research (NBER)
Federal Reserve Bank of San Francisco - Center for Pacific Basin Monetary & Economic Studies
Review of International Economics, Vol. 15, No. 5, pp. 916-931, November 2007
This paper studies how nontraded goods limit the ability of a country to finance current account deficits. It uses an intertemporal model of the current account for a small open economy where goods are endogenously nontraded due to explicit trade costs. The economy has an endowment of two goods with differing trade costs, either of which can be traded or nontraded in equilibrium. The model implies that current account deficits impose a cost, in the form of raising the effective interest rate in the country. The findings differ from some recent studies: first, in that the interest rate rises even for countries with modest current account deficits; secondly, the interest rate cost eventually reaches an upper bound as current account deficits grow, and progressively more nontraded goods become traded to service the debt. Panel regression analysis of interest rate and current account data is consistent with our conclusions.
Number of Pages in PDF File: 16Accepted Paper Series
Date posted: October 22, 2007
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