Puzzles in international macroeconomics

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Puzzles in international macroeconomics
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Six major puzzles in international
macroeconomics search for a common cause

• Obsteld M. and K. Rogoff,  The Six Major Puzzles
  in International Macroeconomics Is There a
  Common Cause?, 2000, NBER Working paper 7777.
• Home bias in trade
• Saving-investment puzzle
• Equity home bias
• Consumption correlation puzzle
• Purchasing Power Parity
• Exchange rate disconnect

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By explicitly introducing trade costs, one can go
far toward explaining a great number of the main
empirical puzzles.Trade costs may include
transportation costs, tariffs, non-tariff
barriers
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Home bias in trade

• International markets are more segmented then is
  commonly supposed
• There is a substantial border effect that reduce
  cross-country trade
• How big is the border effect? Can the market
  segmentation be explained by trade costs of the
  reasonable size?

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How big is the border effect?

• McCallum 1996, National Borders Matter Canada-US
  regional trade patterns, American Economic Review
  85, pp. 615-623

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Trade across individual Canadian provinces was
22 times higher then between individual Canadian
provinces and US states!
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Is anything wrong with McCallums estimation of
the border effect

• Asymmetric effect on countries of different size
• Misspecification of the gravity equation
• Anderson and Wincoop (2003), Gravities with
  Gravitas A solution to the Border puzzle,
  American Economic Review 93, pp. 170-192
• National borders reduce trade between the US and
  Canada by about 44, while reducing trade among
  other industrialized countries by about 30.
  McCallum's spectacular headline number is the
  result of a combination of omitted variables bias
  and the small size of the Canadian economy.
  Within-Canada trade rises by a factor 6 due to
  the border. In contrast, within-US trade rises
  25.

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Asymmetric effect on countries of different size
numerical example

• With no trade barriers, Canada exports 90 of GDP
  to the US and sells 10 internally
• Suppose the border effect reduces cross-border
  trade by 50
• Then, Canada imports 45 of GDP to US and trade
  55 internally
• So, internal trade went up by 5.5 times, cross
  border trade went down by 50, and so internal
  trade has increased by 11 times more then
  cross-border trade
• For US, it used to import 10 of GDP and now
  imports 5. Cross-state trade has increased by
  2.1 times more then cross-border trade

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Home bias in trade

• Obstfeld, Rogoff 2000
• Average size trade costs combined with high
  elasticities of substitution of home for foreign
  goods can account for large part of home bias
• In addition, exchange rate uncertainty and
  difference in tastes across countries also leads
  to higher home good consumption

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Empirical estimates of ?

• Trefler and Lai (1999) ?5.2
• panel of 28 industries in 36 countries for the
  period 1972-1992
• Cheung, Finn, and Fujji (1999) ?3.5-4
• monopolistic competition model
• two-digit industry level data for OECD countries
• Hummels (1999a) ?5.6

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Empirical estimates of trade costs
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Saving-investment puzzle

• Feldstein, Martin, and Charles Horioka (1980)
  Domestic Savings and International Capital
  Flows, Economic Journal 90 (358) June, 314-329.
• Correlation between savings and investments in
  OECD countries is much greater then predicted by
  economic models

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Equity home bias

• Equity home bias (Kenneth R. French James M.
  Poterba, (1991), Investor Diversification and
  International Equity Markets The American
  Economic Review, Vol. 81, No. 2.)
• Economic agents prefer to keep their wealth in
  home assets. They diversify their portfolio less
  then predicted by models of risk-sharing and are
  overly optimistic about returns on home assets
• At the end of the 80th, Americans held 94 percent
  of their wealth in the US stock market, whereas
  Japanese held 98 percent of their equity wealth
  at home

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Consumption correlation puzzle

• Consumption correlation puzzle (Backus, Kehoe,
  and Kydland 1992, International Real Business
  Cycles, Journal of Political Economy 100, pp.
  745-775 )
• International output growth rates are more highly
  correlated then consumption growth rates

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Purchasing Power Parity

• Purchasing Power Parity (Rogoff, Kenneth (1996),
  The Purchasing Power Parity Puzzle, Journal of
  Economic Literature, Vol.34, No. 2., pp.
  647-668.)
• Does not hold in a short run, there are some
  evidence that it holds over the long horizon

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Exchange rate disconnect

• Exchange rate disconnect (Baxter, M and A.
  Stockman, 1989, Business Cycles and Exchange Rate
  regime some international evidence, Journal on
  Monetary Economics, 23, pp. 377-400)
• Weak connection between exchange rates and
  virtually any macroeconomic aggregates