Trade Wedges, Inventories, and International Business Cycles
52 Pages Posted: 9 Jul 2012
Date Written: May 1, 2012
The large, persistent fluctuations in international trade that cannot be explained in standard models by changes in expenditures and relative prices are often attributed to trade wedges. We show that these trade wedges can reflect the decisions of importers to change their inventory holdings. We find that a two-country model of international business cycles with an inventory management decision can generate trade flows and wedges consistent with the data. Moreover, matching trade flows alters the international transmission of business cycles. Specifically, real net exports become countercyclical and consumption is less correlated across countries than in standard models. We also show that ignoring inventories as a source of trade wedges substantially overstates the role of trade wedges in business cycle fluctuations.
Keywords: Inventory, Net Exports, Trade Volatility, International Comovement
JEL Classification: E31, F12
Suggested Citation: Suggested Citation