Trade and Uncertainty

54 Pages Posted: 25 Jun 2014  

Dennis Novy

University of Warwick; Centre for Economic Policy Research (CEPR); Centre for Economic Performance (CEP); CESifo (Center for Economic Studies and Ifo Institute)

Alan M. Taylor

University of California, Davis - Department of Economics; University of Virginia - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: May 24, 2014

Abstract

We offer a new explanation as to why international trade is so volatile in response to economic shocks. Our approach combines the uncertainty shock idea of Bloom (2009) with a model of international trade, extending the idea to the open economy. Firms import intermediate inputs from home or foreign suppliers, but with higher costs in the latter case. Due to fixed costs of ordering firms hold an inventory of intermediates. We show that in response to an uncertainty shock firms optimally adjust their inventory policy by cutting their orders of foreign intermediates disproportionately strongly. In the aggregate, this response leads to a bigger contraction in international trade flows than in domestic economic activity. We confront the model with newly-compiled monthly aggregate U.S. import data and industrial production data going back to 1962, and also with disaggregated data back to 1989. Our results suggest a tight link between uncertainty and the cyclical behavior of international trade.

Keywords: uncertainty shock, trade collapse, inventory, real options, imports, intermediates

JEL Classification: E30, F10

Suggested Citation

Novy, Dennis and Taylor, Alan M., Trade and Uncertainty (May 24, 2014). CESifo Working Paper Series No. 4819. Available at SSRN: https://ssrn.com/abstract=2458300

Dennis Novy (Contact Author)

University of Warwick ( email )

Department of Economics
Coventry CV4 7AL
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HOME PAGE: http://www2.warwick.ac.uk/fac/soc/economics/staff/faculty/novy/

Centre for Economic Policy Research (CEPR) ( email )

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Alan M. Taylor

University of California, Davis - Department of Economics ( email )

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HOME PAGE: http://www.econ.ucdavis.edu/faculty/amtaylor/

University of Virginia - Department of Economics ( email )

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HOME PAGE: http://people.virginia.edu/~amt7u

National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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