Lumpy Trade and Large Devaluations

George Alessandria (), Joseph P. Kaboski and Virgiliu Midrigan
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Virgiliu Midrigan: Federal Reserve Bank of Minneapolis

No CAS_RN_2007_4, Working Papers from Laboratory for Macroeconomic Analysis

Abstract: We document that trade flows, at the micro-economic level, are lumpy an infrequent; inventory management problems faced by importers are more severe than those faced by firms that purchase material inputs domestically; and that a non-trivial component of international trade costs is independent of a shipment’s size. We show that a parsimoniously parameterized (S, s)- type economy successfully accounts for these features of the data. We then show that the model predicts that, in response to a large increase in the relative price of imported goods, import values and the number of distinct imported varieties drops immediately, and as result, short-run import elasticities are substantially larger than long-run elasticities. The model also predicts that importers find optimal to reduce markups in response to the increase in the wholesale price of imports and thus partly rationalizes the slow increase in tradeable goods’ prices following large devaluations. Our study of 6 current account reversals following large devaluation episodes in the last decade provide strong support for the model’s predictions.

Date: 2007-02
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