TRADE COSTS, TRADE BALANCES AND CURRENT ACCOUNTS: AN APPLICATION OF GRAVITY TO MULTILATERAL TRADE

Giorgio Fazio, Ronald MacDonald () and Jacques Melitz

Working Papers from Department of Economics, University of Glasgow

Abstract: In this paper we test the well-known hypothesis of Obstfeld and Rogoff (2000) that trade costs are the key to explaining the so-called Feldstein-Horioka puzzle. Our approach has a number of novel features. First, we focus on the interrelationship between trade costs, the trade account and the Feldstein-Horioka puzzle. Second, we use the gravity model to estimate the effect of trade costs on bilateral trade and, third, we show how bilateral trade can be used to draw inferences about desired trade balances and desired intertemporal trade. Our econo-metric results provide strong support for the Obstfeld and Rogoff hypothesis and we are also able to reconcile our results with the so-called home bias puzzle.

Keywords: Feldstein-Horioka puzzle; trade costs; gravity model; home bias puzzle; current account; trade balance (search for similar items in EconPapers)
JEL-codes: F10 F32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cba and nep-int
Date: 2007-07
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Downloads: (external link)
http://www.gla.ac.uk/media/media_33618_en.pdf (application/pdf)

Related works:
Working Paper: Trade Costs, Trade Balances and Current Accounts: An Application of Gravity to Multilateral Trade (2005)
Working Paper: Trade Costs, Trade Balances and Current Accounts: An Application of Gravity to Multilateral Trade (2005)
Working Paper: Trade Costs, Trade Balances and Current Accounts: An Application of Gravity to Multilateral Trade (2005)
Journal Article: Trade Costs, Trade Balances and Current Accounts: An Application of Gravity to Multilateral Trade (2008)
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Persistent link: http://EconPapers.repec.org/RePEc:gla:glaewp:2007_18

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