A Model of Endogenous Nontradability and its Implications for the Current Account

Abstract

This paper analyzes how a model where goods are endogenously nontraded can help explain the relationship between the current account and real exchange rate fluctuations. We formulate a small open economy two-period model in which goods switch endogenously between being traded or nontraded. The model demonstrates how movements in the real exchange rate and real interest rate can impose significant costs on intertemporal trade. The model also shows that a variety of nonlinear relationships is possible between the current account and real exchange rate, depending on the relative transport costs and substitutability in preferences between goods. In contrast to recent work, our analysis implies that such costs of intertemporal trade may be a concern for many countries, not just those with large current account imbalances.

Keywords: Trade, prices, econometric models

JEL Classification: F4