Business Cycle Accounting of Trade Barriers in a Small Open Economy

Abstract

To what extent a short-term decline in the output of a small open economy can be explained by trade barriers? To answer, we extend the standard four-wedge Business Cycle Accounting method of Chari et al. (2007) to a five-wedge small open economy model by adding a time-varying wedge that resembles trade frictions related to the barriers on imports. We show that international sanctions against Iranian economy is a good example of trade barriers, therefore we apply this method to Iran data for recession of 2012-13. The results indicate that efficiency and investment wedges account for most of the fluctuations during the sanction period, and trade barriers had little explanatory power.

Keywords: Trade barriers, Business Cycle Accounting, Small open economy, International sanctions