Elasticity Optimism

Abstract

This working paper was written by Jean Imbs (HEC Lausanne, Swiss Finance Institute and CEPR) and Isabelle Méjean (Ecole Polytechnique).

Estimates of the elasticity of substitution between domestic and foreign varieties are small in macroeconomic data, but substantially larger in disaggregated microeconomic studies. This may be an artifact of heterogeneity. We use disaggregated multilateral trade data to structurally identify elasticities of substitution in US goods. We spell out a partial equilibrium model to aggregate them adequately at the country level. We compare aggregate elasticities that impose equality across sectors, to estimates allowing for heterogeneity. The former are similar in value to conventional macroeconomic estimates; but they are more than twice larger - up to 5 - with heterogeneity. The parameter is central to calibrated models in most of international economics. We discuss the difference our corrected estimate makes in various areas of international economics, including the dynamics of external balances, the international transmission of shocks, international portfolio choice and optimal monetary policy.

Keywords: Trade Elasticities, Aggregation, Calibration, Global Imbalances, International Transmission, International Portfolio, Monetary Policy

JEL Classification: F41, F32, F21