Trade in the Global Recession (EKNR) and Obstfeld and Rogoff s International Macro Puzzles: A Quantitative Assessment (EKN) University of Chicago

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1 Trade in the Global Recession (EKNR) and Obstfeld and Rogoff s International Macro Puzzles: A Quantitative Assessment (EKN) Brent Neiman University of Chicago June 2016

2 Introduction International macro models typically have 2-countries without serious geography, limited I/O structure Trade models typically static, no capital and ignore the future Often, this is fine. But what if need dynamic and realistic representation of sector-country linkages?

3 Application 1: Trade and the Global Recession Global Manufacturing Trade/GDP Dropped nearly 25% Log Index (2008Q3=0) Data 08Q3 09Q Q1

4 Application 1: Trade and the Global Recession Change in Trade GBR AUT DNK ESP FRA USA ITA DEU KORCAN SWE GRC KOR GRCCZE POL MEX FRA FIN ROU USA MEX DEUGBR DNK AUT CZE POL ITA JPN CAN ROU ESP SWE FIN JPN CHN IND CHN IND Change in Production Durables Nondurables Eichengreen (2009): The collapse of trade has been absolutely terrifying... we lack an adequate understanding of its causes. Many single-country P.E. studies (theory and empirics)

5 Application 2: OR (2001) s 6 Puzzles Feldstein-Horioka (1980): Large and significant coefficient on regressions of investment on saving Data Diff. Saving 0.356** *** 0.866*** (0.146) (0.150) (0.127) (0.197) Observations R-squared Obstfeld and Rogoff (2001) use 2-country stylized model to propose that trade frictions can explain this and other puzzles

6 Application 2: OR (2001) s 6 Puzzles Charles Engel:... we need more study to be able to reconcile their compelling but simplified examples with the results that emerge from simulation of more fully specified dynamic models. John Leahy:... the effects... might turn out to be quantitatively small in a realistically calibrated model.

7 What We Do Multi-country multi-sector dynamic GE framework for analyzing global fluctuations in GDP, production, and trade. Framework extracts shocks that fully explain data and can generate counterfactuals. Similar in spirit to CKM (2007). Use counterfactuals to understand drivers of trade/gdp and quantitatively evaluate O/R s hypothesis

8 Related Literature Trade Collapse: Alessandria, Kaboski, and Midrigan (2010), Amiti and Weinstein (2011), Baldwin (2009), Bems, Johnson, and Yi (2013), Engel and Wang (2011), Leibovici and Waugh (2012), Levchenko, Lewis, and Tesar (2010) International Macro Puzzles: Obstfeld and Rogoff (2001), Corsetti, Dedola, and Leduc (2008), Coeurdacier (2009), Fitzgerald (2012), Rabitsch (2012), Reyes-Heroles (2015) Methodology: Boileau (2002), Chari, Kehoe, McGrattan (2007), Deckle, Eaton, and Kortum (2008), Justiniano, Primiceri, and Tambalotti (2010), Kehoe, Ruhl, and Steinberg (2014), Caliendo and Parro (2014)

9 Agenda Simplified Model Less Sectors No Intermediates No I/O Heterogeneity Key Equations Change Formulation Backing Out Shocks Counterfactuals Applications / Results

10 Simplified Economy: Technology and Preferences Multiple countries n = 1,..., N. Good S ( Services ) is a CES bundle of varieties z [0, 1]. Nontraded and used for consumption. Good D ( Durables ) is a CES bundle of varieties z [0, 1]. Traded and used for investment. Country n may import durable variety from i, subject to d ni,t. Complete markets, no uncertainty, perfect competition

11 Simplified Economy: Technology and Preferences Production in country n of variety z in sector j {D, S}: y j n,t(z) = a j n,t(z)b ( ) β L ( ) β K L j n,t(z) Kn,t(z) j Efficiencies a j n,t(z) drawn from: [ ] Pr an,t(z) j a = exp ( a γa j n,t ) θ Factors of production are constrained by: K n,t = L n,t = K D n,t(z)dz + L D n,t(z)dz K S n,t(z)dz L S nt(z)dz

12 Simplified Economy: Technology and Preferences Capital accumulation: ( ) α In,t K n,t+1 = χ n,t K n,t + (1 δ)k nt K n,t Investment: ( 1 σ/(σ 1) I n,t = xn,t(z) dz) D (σ 1)/σ, 0 where x D n,t(z) is absorption in n of variety z of good D.

13 Simplified Economy: Technology and Preferences Demand shocks allow for changes in relative spending: U n = ρ t φ n,t ln C n,t t=0 Consumption: ( 1 σ/(σ 1) C n,t = xn,t(z) dz) S (σ 1)/σ, 0 where x S n,t(z) = y S n,t(z) is absorption in n on vty z of good S.

14 Simplified Economy: Planner s Problem We solve Planner s problem. Planner uses weights ω n. We impose a restriction so demand has no global component: N ω n φ n,t = 1 n=1 We interpret shadow prices as competitive prices. For example, we replace λ K n,t with r n,t. Planner s Lagrangian

15 Simplified Economy: First Order Conditions Price of Consumption Good: Capital Rental Rates: p S n,t = (w n,t) βl (r n,t ) βk A S n,t Labor Rental Rates: r n,t = p j n,tβ K y j n,t K j n,t w n,t = p j n,tβ L y j n,t L j n,t

16 Simplified Economy: First Order Conditions Price of Investment Good: ( ) θ N pn,t D = (w i,t ) βl (r i,t ) βk d ni,t A D i,t i=1 1/θ Bilateral Trade Shares: ( (w i,t ) βl (r i,t ) βk d ni,t π ni,t = pn,ta D D i,t ) θ

17 Simplified Economy: Consumption Consumption Spending and Production: X S n,t = Y S n,t = p S n,tc n,t = ω n φ n,t Numeraire is world consumption expenditure: N N N N Yn,t S = Xn,t S = pn,tc S n,t = ω n φ n,t = 1 n=1 n=1 n=1 n=1

18 Simplified Economy: Investment Euler Investment Euler (X D n,t = p D n,ti n,t ): ( X D n,t ) 1 α = ρr n,t+1 + ρ pd n,t+1 ( X D n,t+1 ) 1 α p D n,t αχ n,t p D n,tk n,t [ αχ n,t+1 χ n,t+1 (1 α) pn,t+1 D K n,t+1 ( ) X D α n,t+1 + (1 δ)] p D n,t+1 K n,t+1 Setting α = 1 and rearrange to get more standard form: [ ] pn,t D = ρ φ n,t+1 U (C n,t+1 ) p D n,t+1 /χ n,t+1 χ n,t φ n,t U (C n,t ) pn,t+1 S (1 δ) + r n,t+1 /ps n,t pn,t+1 S /ps n,t

19 Simplified Economy: Production, GDP, Factor Payments Durable production Y D n,t must be globally absorbed X D n,t: Y D i,t = N π ni,t Xn,t D n=1 GDP: Y n,t = Y D n,t + Y S n,t

20 Simplified Economy: System in Changes Now, imagine we have data on levels of GDP Y n,s, Consumption Y S n,s, and trade shares π ni,s at some s = t I Assume the path of shocks {ˆχ n,s, Â D n,s, ˆL n,s, ˆφ n,s, ˆd ni,s } s= s=t I +1 in changes (i.e. where ˆx t+1 = x t+1 /x t ) With the vector ˆK n,t I +1, we can iterate system forward. No need to know K n,t I or {χ n,t I, A D n,t I, L n,t I, φ n,t I, d ni,t I } 4 equations x 4 unknowns: Ŷ n,t+1, Ŷ S n,t+1, ˆπ n,t+1, ˆp D n,t+1.

21 Simplified Economy: System in Changes Combining Euler and Law of Motion for Capital: 1 ρ ˆK n,t+1 ˆK n,t+1 (1 δ) ˆX D n,t+1 αβ K Y n,t Ŷ n,t+1 = [ X D n,t (1 α) + 1 ˆχ n,t+1 ( ˆKn,t+1 ˆp D n,t+1 ˆX D n,t+1 ) α ] 1 δ ˆK n,t+1 (1 δ) Consumption (or non-traded Production): ˆX S n,t+1 = Ŷ S n,t+1 = ˆφ n,t+1

22 Simplified Economy: System in Changes Trade Prices: ˆp n,t+1 D N = i=1 π ni,t ( ) βl ( ) βk Ŷi,t+1 Ŷi,t+1 ˆL i,t+1 ˆK i,t+1 Â D i,t+1 ˆd ni,t+1 θ 1/θ Trade Shares: ˆπ ni,t+1 = ( ) βl ( ) βk Ŷi,t+1 Ŷi,t+1 ˆL i,t+1 ˆK i,t+1 ˆp D n,t+1âd i,t+1 ˆd ni,t+1 θ

23 Simplified Economy: System in Changes So, given: 1 Data on Y n,t I, Consumption Y S n,t, and trade shares π I ni,t I, 2 Assumed shock values in changes, and 3 A guess of ˆK n,ti +1, we get {Ŷ n,t I +1, Ŷ S n,t I +1, ˆπ ni,t I +1} and generate t I + 1 levels. We update capital growth with: ˆK n,t I +2 (1 δ) = ˆχ n,t I +1 ( ˆX D n,t I +1 ) α [ ] ˆKn,tI +1 (1 δ) ˆp D n,t I +1 ˆK n,t I +1 Repeat for the change from t I + 1 to t I + 2 and march forward

24 Simplified Economy: Backing Out Shocks Where do shocks and capital (in changes) come from? Step 1: Imagine all shocks stop changing after t E, i.e. {ˆχ s, Â D s, ˆL s, ˆφ n,s, ˆd ni,s } = {1, 1, 1, 1, 1} for s > t E We solve for the vector ˆK n,t E +1 which together with data on Y n,t E, Y S, π n,t E ni,t E leads to a steady state with: ˆK n = Ŷn = Ŷ S n = ˆπ ni = 1

25 Simplified Economy: Backing Out Shocks KK 1.0 Step 1: Find KK t E +1 Data Available t E Shocks Not Changing (Assumption) t

26 Simplified Economy: Backing Out Shocks Step 2: Iterate backwards by substituting LOM for K into Euler (χ cancels!) to get ˆK s+1 for s < t E : ( ) ˆK i,t ˆK i,t (1 δ) = ρβk α Y i,t 1Ŷi,t + ρ ˆX D 1 δ Xi,t 1 D i,t (1 α) + ˆK i,t+1 (1 δ) KK Step 2: Find {KK t } 1.0 Data Available t E Shocks Not Changing (Assumption) t

27 Simplified Economy: Backing Out Shocks Step 3: Given paths of ˆK n,t+1, Ŷ n,t+1, Ŷ S n,t+1, ˆpD n,t+1, and ˆπ ni,t+1, can back out five shocks to fit data 1 Labor Shocks ˆL n,t+1 from the data 2 Demand Shocks from consumption spending growth: ˆφ n,t+1 = ˆX C n,t+1 = Ŷ C n,t+1 3 Productivity Shocks from the Dual: Â D n,t+1 = ( ) β L ( ) β K Ŷn,t+1 Ŷn,t+1 ˆL n,t+1 ˆK n,t+1 ˆp D n,t+1 (ˆπ nn,t+1 ) 1/θ

28 Simplified Economy: Backing Out Shocks Step 3 Cont d: Given paths of ˆK n,t+1, Ŷ n,t+1, Ŷ S n,t+1, ˆp D n,t+1, and ˆπ ni,t+1, can back out all other shocks to fit data 4 We back out trade frictions as: ( ) 1/θ ˆπni,t+1 ˆp n,t+1 ˆd D ni,t+1 = ˆπ ii,t+1 ˆp i,t+1 D 5 We can then back out investment efficiencies as: ˆχ n,t+1 = ˆK ( ) α n,t+2 (1 δ) ˆX D n,t+1 ˆK n,t+1 (1 δ) ˆp n,t+1 D ˆK, n,t+1 Note: we don t need χ n,t, A D n,t, L n,t, φ n,t, d ni,t, or K n,t.

29 Simplified Economy: Counterfactuals Can analyze shocks on their own, can also run counterfactuals Some period, expectations about the future change We solve system forward from pre-shock initial conditions {Y n,t, Y S n,t, π ni,t, ˆK n,t+1 } but along new shock path 3 of the 4 equations of the system in changes apply. But investment În,t+1 must transition to new perfect foresight path, so Euler (4th equation) doesn t hold that quarter We solve this by guessing investment spending, iterating forward, and seeing if converge to SS. If not, new guess...

30 Non-Simplified Model Used in Applications 1 N = 19 or 21, four sectors j Ω = {C, D, N, S} 2 Output from sectors C and D accumulate into capital stocks 3 Output from sectors N and S can be consumed 4 Sectors D and N are tradable, sectors C and S are not 5 Production combines factors K C, K D, and L with intermediates from j Ω 6 Input shares are country-sector specific: β K,jk i 7 Feed in exogenous deficits in the S sector, β L,j i, and β M,jl i 8 Relative demand for N and S impacted by ψ N n,t

31 Today s Agenda Simplified Open-Economy Example Application 1: Trade and the Global Recession Application 2: Obstfeld and Rogoff s Int l Macro Puzzles

32 EKNR: Trade and the Global Recession 08Q309Q2 11Q1 Trade and Construction (Relative to Global GDP) Production (Relative to Global GDP) Trade Construction Production

33 EKNR: Trade and the Global Recession Change in Trade SWE GBR AUT DNK ESP FRA USA ITA DEU KORCAN SWE GRC KOR GRCCZE POL MEX FRA FIN ROU USA MEX DEUGBR DNK AUT CZE POL ITA JPN CAN ROU ESP FIN JPN CHN IND CHN IND Change in Trade IND CHN KORCHN ROU SWE MEX GBR JPNCZE CAN IND KOR USA POL MEX ESP ROU CZE JPN POL DEU AUT FIN USAITA ITA CAN FRA DEU SWE ESP FIN AUT DNKGBR FRA DNK GRC GRC Change in Production Change in Production Durables Nondurables Durables Nondurables Change in Construction CHN ROU JPN POL CAN IND DEU CANJPN ESP GRC KOR AUTUSA ITA FRA DNK DEU SWE FIN GBR FIN AUT MEX CZE MEX CZE DNK FRA ITA GBR POL ROU USA ESP GRC CHN SWE IND KOR Change in Relative GDP GRC FIN JPN USA POL CHN SWE ROW CAN KOR MEX POL IND GRC AUT FRA JPN ITA DEUESP DNK KOR CAN ROW GBR DNK CZE AUT FIN DEU CZE SWE GBR USA FRA ITA ESP ROU MEX ROU IND CHN Change in Production Change in Real GDP Global Recession Recovery Global Recession Recovery

34 EKNR: Trade and the Global Recession We calibrate parameters and get I-O coefficients from OECD We use quarterly data in levels on: 1 Sectoral production Y j n,t 2 Bilateral trade shares in each sector π j ni,t 3 Services deficits D S n,t We use quarterly data in changes on: 1 Sectoral prices ˆp j n,t 2 Growth in labor supply ˆL j ni,t

35 EKNR: Algorithm to Back Out Shocks Change in Capital Stock Structures Change in Capital Stock Durables United States China Rest of World

36 EKNR: Backed-Out Shock Values ˆd i D ˆd i N DS i Yi F Prior Global Recov Prior Global Recov Prior Global Recov Period Recession Period Period Recession Period Period Recession Period World Canada China France Germany India Italy Japan Mexico United Kingdom United States Rest of World Comparison to LLT

37 EKNR: Backed-Out Shock Values  C i  D i  N i Prior Global Recov Prior Global Recov Prior Global Recov Period Recession Period Period Recession Period Period Recession Period World Canada China France Germany India Italy Japan Mexico United Kingdom United States Rest of World

38 EKNR: Global Trade Counterfactuals Comparison of Domar-weighted Aggregate TFP United States TFP Growth Fernald (Business Sector) EKNR (Aggregate Economy) Other Countries

39 EKNR: Backed-Out Shock Values ˆχ C i ˆχ D i Prior Global Recov Prior Global Recov Prior Global Recov Period Recession Period Period Recession Period Period Recession Period ˆφ i World Canada China France Germany India Italy Japan Mexico United Kingdom United States Rest of World Vs. Prod

40 EKNR: Global Trade Counterfactuals Index (2008Q3=1) Q3 09Q2 11Q Actual Data (i.e. All Shocks) Nondurables Demand Aggregate Demand Productivities Inv. Efficiency in Durables Inv. Efficiency in Structures Trade Frictions Services Deficits

41 EKNR: Country Trade Counterfactuals Changes in Counterfactual Trade Friction Shocks ROU CZE DNK FRA ITA DEU GRC JPN MEX GBR POL ESP ROW USA KOR SWE CANAUTIND CHN FIN Changes in Trade in Data Changes in Counterfactual Inv. Efficiency in Durables Shocks IND CHN CAN JPN AUT FIN ITA DEU DNK FRA KOR GRC CZE ESP ROW SWE USA GBR POL MEX ROU Changes in Trade in Data Changes in Counterfactual Inv. Efficiency in Structures Shocks FIN ROU SWE CZE CAN ESP POL ITA MEX DEUGRC ROW AUT DNKCHN USA GBR FRA IND JPN KOR Changes in Trade in Data Changes in Counterfactual Demand Shocks SWE CZE CAN POL MEX FIN IND DEU ITA AUT KOR ROUESP ROW DNKCHN USA GBR FRA JPN GRC Changes in Trade in Data

42 EKNR: Country GDP Counterfactuals Changes in Counterfactual Trade Friction Shocks ROU CZE DNK KORESP DEU ITA AUT FRA GRC IND POL MEXSWE GBR USA CAN FIN ROW JPN CHN Changes in GDP in Data Changes in Counterfactual Inv. Efficiency in Durables Shocks ROU CZE CAN DNK AUT FRA GRC POL MEX FIN DEU ITA IND SWE GBR KOR ESP USA ROW CHN JPN Changes in GDP in Data Changes in Counterfactual Inv. Efficiency in Structures Shocks ROU CAN AUT CZE FIN DNK KORESP DEU ITA FRA GRC USA SWE GBR ROW IND MEX POL CHN JPN Changes in GDP in Data Changes in Counterfactual Demand Shocks USA ITA FIN AUT CZE ROW KOR DEU ESP FRAGRC DNK IND SWE CAN ROU POL MEX GBR JPN CHN Changes in GDP in Data

43 EKNR: Impact of Non-DEU Shocks Changes in Counterfactual DEU AUT FRA JPN GRC CAN CZE DNK USA GBR IND ROW MEX ITA KOR SWE ESP POL FIN ROU Imports CHN Changes in Imports in Data Changes in Counterfactual Exports POL DNK AUT FRA GRC IND KOR ITA GBRUSA ROW ESP CHN CZEDEU MEXROU SWE JPN FINCAN Changes in Exports in Data Changes in Counterfactual Production DEU AUT DNK USA JPN FRA POL GRC KOR CAN CZE ITA FINMEX ESP SWE GBR ROW ROU CHN IND Changes in Production in Data Changes in Counterfactual GDP USA DEUGRC AUT IND ITA FRA DNK CAN FINKOR ESP ROW CZE MEX POL ROU SWE GBR CHN JPN Changes in GDP in Data Impact of Only U.S. Shocks

44 EKNR: Conclusions Decline in Trade during global recession primarily reflected change in spending composition away from tradables Shift in composition driven by durables investment shocks, not others (contemporaneous or future) Changes in relative nominal GDPs due to demand shocks Foreign shocks critical for some countries like DEU, domestic shocks matter most for others like USA Additional Uses for Framework: Impact of China slowdown? Recent global trade decline (See IMF WEO)?.

45 Today s Agenda Simplified Closed-Economy Example Simplified Open-Economy Example Application 1: Trade and the Global Recession Application 2: Obstfeld and Rogoff s Int l Macro Puzzles

46 Introduction Obstfeld and Rogoff (Macro Annual 2001, OR ) see international macro as replete with puzzles: 1 Home Bias in Absorption 2 Feldstein-Horioka Puzzle 3 Home Bias in Equities 4 Low Consumption Correlation 5 Failure of Relative Purchasing Power Parity 6 Exchange Rate Disconnect OR propose that all six can be accounted for by trade frictions Killing 6 birds with one stone! Plus, trade frictions are easier to measure than capital market imperfections OR s story is provocative, but does it have quantitative bite?

47 Generate World Without Trade Costs Remember we extract trade costs from data with: ( ) π j 1/θ ˆd j ni,t+1 = ni,t+1 /πj ni,t p j n,t+1 /pj n,t π j ii,t+1 /πj ii,t p j i,t+1 /pj i,t But trade cost reductions that hypothetically bring free trade would result in π j ni,t+1 = πj ii,t+1 and in pj n,t+1 = pj i,t+1 So we can implement a counterfactual with: ˆd j,ft ni,t+1 = ( π j ii,t π j ni,t ) 1/θ p j i,t p j n,t

48 Generate World Without Trade Costs We have data on π ni,t as before We obtain (p j i,t /pj n,t) from the World Bank s ICP, using Machinery and Equipment for durables and Food and beverages and Clothing and Footwear for nondurables. We run counterfactuals from initial levels in 2000:Q1, where all shocks are taken from the data except that ˆd j j,ft ni,t+1 = ˆd ni,t+1 for 2000:Q2 and ˆd j ni,t+1 = 1 thereafter After transition, think of system as behaving as if it had no trade frictions but was otherwise identical

49 Counterfactual World Trade Global Trade / GDP Baseline Frictionless Trade

50 Counterfactual Deficits United States Japan Trade Deficit / GDP Trade Deficit / GDP Germany Rest of World Trade Deficit / GDP Trade Deficit / GDP Baseline Frictionless Trade

51 Puzzle 1: Home Bias in Trade Ratio of Home Purchases to Imports in 2005:Q4 Country Baseline Frictionless Trade Durables Nondurables Durables Nondurables Austria Canada Czech Republic Denmark Finland Germany Greece India Italy Japan Mexico Poland Romania South Korea Spain Sweden United Kingdom United States Rest of World

52 Puzzle 1: Home Bias in Trade Gravity Regressions in 2005:Q4 Country Baseline Frictionless Trade Durables Nondurables Durables Nondurables Distance *** *** (0.113) (0.105) (0.000) (0.000) Contiguous (0.200) (0.210) (0.000) (0.000) Common Language 0.508*** 0.554*** (0.163) (0.120) (0.000) (0.000) Constant *** *** (0.187) (0.167) (0.000) (0.000) Importer FE YES YES YES YES Exporter FE YES YES YES YES Observations R-squared

53 Puzzle 2: Feldstein-Horioka (Baseline) Investment / GDP GRC KOR ROU IND ESP ITA JPN CAN CZE AUT FIN MEX POL ROW GBR DEU USA SWE DNK Investment / GDP GRC KOR ROU ESP CZE INDITA JPN ROW POL MEX AUT CAN FIN USA GBR DEU SWE DNK Saving / GDP Saving / GDP Investment / GDP GRC IND ROU CAN FIN POL ROW CZE AUT GBR ESP ITA JPN MEX DEU SWE USA DNK KOR Saving / GDP Change in Investment / GDP Long Difference IND KOR FIN CAN AUT POL ROU DNK GBR ROW JPN DEU ITA MEX SWE USA ESP CZE GRC Change in Saving / GDP

54 Puzzle 2: Feldstein-Horioka (Counterfactual) Investment / GDP ROW JPN USA DEU GBR IND POL KOR ITA MEX ROU CAN ESP GRC AUT FINCZE DNK SWE Investment / GDP ROW JPN USA GBR DEU ESP MEX ITA GRCIND POL KOR ROU FINCZE CANAUT DNK SWE Saving / GDP Saving / GDP Investment / GDP ROW JPN DEU USA GBR IND POL ROU KOR ITA CAN AUT CZE DNK ESP MEX FIN GRC SWE Saving / GDP Change in Investment / GDP Long Difference DNK ROU ROW IND SWE CANDEU GBR AUT KOR ITAFINPOL ESP CZEJPN USA GRC MEX Change in Saving / GDP

55 Puzzle 2: Feldstein-Horioka Dependent Variable: Investment Baseline Frictionless Trade Long Difference Long Difference Saving 0.378** 0.254* 0.630*** 0.881*** 0.146** 0.148** (0.134) (0.142) (0.120) (0.179) (0.068) (0.058) (0.092) (0.441) Constant 0.144*** 0.174*** *** *** 0.280*** 0.232*** * (0.032) (0.034) (0.028) (0.010) (0.041) (0.036) (0.053) (0.042) Observations R-squared

56 Puzzle 4: Low International Consumption Correlations Density Bilateral Consumption Correlation Baseline Frictionless Trade

57 Puzzle 4: Low International Consumption Correlations Moments of Distribution of Bilateral Pairs Quarterly Annual Baseline Frictionless Trade Baseline Frictionless Trade Mean Median Maximum Minimum

58 Puzzle 5: Relative Purchasing Power Parity Standard Deviation of Inflation Across Countries Quarterly Annual Baseline Frictionless Trade Baseline Frictionless Trade Construction Durables Nondurables Services CPI

59 Puzzle 6: Exchange Rate Disconnect Variation in Nominal GDP, Real GDP, Real Exchange Rate Quarterly Annual Baseline Frictionless Trade Baseline Frictionless Trade Nominal Real Nominal Real Nominal Real Nominal Real RER RER RER GDP GDP GDP GDP GDP GDP GDP GDP RER Austria Canada Czech Republic Denmark Finland Germany Greece India Italy Japan Mexico Poland Romania South Korea Spain Sweden United Kingdom United States Rest of World Pooled

60 Puzzle 6: Exchange Rate Disconnect Dependent Variable: Log Change in Real GDP Quarterly Annual Baseline Frictionless Trade Baseline Frictionless Trade Log Change in Nominal GDP 0.099*** 0.064*** 0.401*** 0.369*** 0.257*** 0.146*** 0.627*** 0.505*** (0.019) (0.017) (0.024) (0.021) (0.045) (0.027) (0.062) (0.041) Constant 0.019* *** 0.138*** 0.019*** 0.013*** 0.108*** 0.100*** (0.006) (0.008) (0.007) (0.007) (0.007) (0.004) (0.005) (0.003) Country FE NO YES NO YES NO YES NO YES Time FE YES YES YES YES YES YES YES YES Observations R-squared

61 EKN Conclusions Obstfeld and Rogoff s proposition has quantitative bite We knew we needed trade frictions to explain bilateral trade Eliminating trade frictions large enough to explain home bias and gravity goes far in open-economy macro puzzles

62 Overall Conclusions Framework can be confronted with realistic data on many countries to back out country sector quarter specific shocks. Many obvious additional applications: Impact of China crash? Monetary policy transmission? Relevance of invoicing currency? Imbalances within Eurozone? Next steps for model include incorporating: Uncertainty Imperfect Competition Nominal Rigidities Financial Market Frictions

63 Extra Slides

64 Simplified Economy: Planner s Problem L = N n=1 t=0 ρ t ω n φ n,t ln C n,t + ρ t λ L n,t L n,t j Ω L j n,t(z)dz + ρ t λ K n,t K n,t Kn,t(z)dz j j Ω 0 + ρ 1 [ ( ) β t λ j n,t(z) an,t(z)b j L j L ( ) ] β n,t(z) Kn,t(z) j K yn,t(z) j j Ω Back

65 Simplified Economy: Planner s Problem... [ ( 1 ] + ρ t λ S n,t 0 y S n,t(z) (σ 1)/σ dz) σ/(σ 1) C n,t [ ( 1 σ/(σ 1) ] + ρ t λ D n,t xn,t(z) dz) D (σ 1)/σ I n,t [ 1 + ρ t ˆλ D n,t(z) yn,t(z) D 0 0 ] N d mn,t xmn,t(z) D dz m=1 [ 1 N ] + ρ t λ D n,t(z) xni,t(z) D xn,t(z) D dz 0 + ρ t λ V n,t i=1 [χ n,t (I n,t ) α (K n,t ) 1 α + (1 δ)k n,t K n,t+1 ], plus non-negativity and transversality Back

66 Simplified Economy: Consumption and Investment Investment Euler: ( X D n,t ) 1 α = ρr n,t+1 + ρ pd n,t+1 ( X D n,t+1 ) 1 α p D n,t αχ n,t p D n,tk n,t [ αχ n,t+1 χ n,t+1 (1 α) pn,t+1 D K n,t+1 ( ) X D α n,t+1 + (1 δ)] p D n,t+1 K n,t+1 Divide the LHS by ω n = p S n,tc n,t /φ n,t and the RHS by ω n = p S n,t+1 C n,t+1/φ n,t+1, and substitute α = 1 to get: [ ] pn,t D = ρ φ n,t+1 U (C n,t+1 ) p D n,t+1 /χ n,t+1 χ n,t φ n,t U (C n,t ) pn,t+1 S (1 δ) + r n,t+1 /ps n,t pn,t+1 S /ps n,t Back

67 EKNR (2015): Benefit of Multi-Sector, Multi-Country Sector- and bilateral-specific wedges important for full story Compare our U.S. import demand wedge to LLT (2010): ( ) wedge = ln ˆX M n,t+1 θ ln ˆP n,t+1 ˆP M n,t+1 ln ˆX n,t+1 Overall, Non-Oil Durables Consumption LLT Manufacturing Durables Nondurables EKNR But LLT can only look at U.S. imports by sector. We find largely offsetting positive wedges elsewhere. Back

68 EKNR (2015): Impact of Only U.S. Shocks Changes in Counterfactual Imports ROU MEX FRA FIN SWE ESP POL ITA CZEDNK DEU IND KOR AUT GBR JPN GRC ROW CAN USA CHN Changes in Imports in Data Changes in Counterfactual FIN CZE AUT DEU ITA POL ROW SWE GBR ESP FRA DNK CHN GRCIND ROUKOR JPN CAN Exports USA MEX Changes in Exports in Data Changes in Counterfactual Production CZE FIN ROW ROU SWEGBR POL ITA ESP DEUGRC FRA KOR AUT DNKJPN MEX USA CAN IND CHN Changes in Production in Data Changes in Counterfactual GDP POL ROU USA CZE KOR SWE GBR FIN DNK DEU ESP ITA AUT FRA GRC MEX ROW IND CAN CHN JPN Changes in GDP in Data Back

69 EKNR (2015): Global Trade Counterfactuals Comparison of Domar-weighted Aggregate TFP AUT00 AUT00 AUT00 AUT01 AUT01 AUT01 AUT01 AUT02 AUT02 AUT02 AUT02 AUT03 AUT03 AUT03 AUT03 AUT04 AUT04 AUT04 AUT04 AUT05 AUT05 AUT05 AUT05 AUT06 AUT06 AUT06 AUT06 AUT07 AUT07 AUT07 AUT07 AUT08 AUT08 AUT08 AUT08 AUT09 AUT09 AUT09 AUT09 AUT10 AUT10 AUT10 AUT10 AUT11 AUT11 AUT11 AUT11 AUT12 AUT12 AUT12 AUT12 CAN00 CAN00 CAN00 CAN01 CAN01 CAN01 CAN01 CAN02 CAN02 CAN02 CAN02 CAN03 CAN03 CAN03 CAN03 CAN04 CAN04 CAN04 CAN04 CAN05 CAN05 CAN05 CAN05 CAN06 CAN06 CAN06 CAN06 CAN07 CAN07 CAN07 CAN07 CAN08 CAN08 CAN08 CAN08 CAN09 CAN09 CAN09 CAN09 CAN10 CAN10 CAN10 CAN10 CAN11 CAN11 CAN11 CAN11 CAN12 CAN12 CAN12 CAN12 DNK00 DNK00 DNK00 DNK01 DNK01 DNK01 DNK01 DNK02 DNK02 DNK02 DNK02 DNK03 DNK03 DNK03 DNK03 DNK04 DNK04 DNK04 DNK04 DNK05 DNK05 DNK05 DNK05 DNK06 DNK06 DNK06 DNK07 DNK06 DNK07 DNK07 DNK07 DNK08 DNK08 DNK08 DNK08 DNK09 DNK09 DNK09 DNK09 DNK10 DNK10 DNK10 DNK10 DNK11 DNK11 DNK11 DNK11 DNK12 DNK12 DNK12 DNK12 FIN00 FIN00 FIN00 FIN01 FIN01 FIN01 FIN01 FIN02 FIN02 FIN02 FIN02 FIN03 FIN03 FIN03 FIN03 FIN04 FIN04 FIN04 FIN04 FIN05 FIN05 FIN05 FIN05 FIN06 FIN06 FIN06 FIN06 FIN07 FIN07 FIN07 FIN07 FIN08 FIN08 FIN08 FIN08 FIN09 FIN09 FIN09 FIN09 FIN10 FIN10 FIN10 FIN10 FIN11 FIN11 FIN11 FIN11 FIN12 FIN12 FIN12 FIN12 FRA03 FRA03 FRA03 FRA04 FRA04 FRA04 FRA04 FRA05 FRA05 FRA05 FRA05 FRA06 FRA06 FRA06 FRA06 FRA07 FRA07 FRA07 FRA07 FRA08 FRA08 FRA08 FRA08 FRA09 FRA09 FRA09 FRA09 FRA10 FRA10 FRA10 FRA10 FRA11 FRA11 FRA11 FRA11 FRA12 FRA12 FRA12 FRA12 DEU00 DEU00 DEU00 DEU01 DEU01 DEU01 DEU01 DEU02 DEU02 DEU02 DEU02 DEU03 DEU03 DEU03 DEU03 DEU04 DEU04 DEU04 DEU04 DEU05 DEU05 DEU05 DEU05 DEU06 DEU06 DEU06 DEU06 DEU07 DEU07 DEU07 DEU07 DEU08 DEU08 DEU08 DEU08 DEU09 DEU09 DEU09 DEU09 DEU10 DEU10 DEU10 DEU10 DEU11 DEU11 DEU11 DEU11 DEU12 DEU12 DEU12 DEU12 ITA00 ITA00 ITA00 ITA01 ITA01 ITA01 ITA02 ITA01 ITA02 ITA02 ITA02 ITA03 ITA03 ITA03 ITA03 ITA04 ITA04 ITA04 ITA04 ITA05 ITA05 ITA05 ITA05 ITA06 ITA06 ITA06 ITA06 ITA07 ITA07 ITA07 ITA07 ITA08 ITA08 ITA08 ITA08 ITA09 ITA09 ITA09 ITA09 ITA10 ITA10 ITA10 ITA10 ITA11 ITA11 ITA11 ITA11 ITA12 ITA12 ITA12 ITA12 JPN00 JPN00 JPN00 JPN01 JPN01 JPN01 JPN01 JPN02 JPN02 JPN02 JPN02 JPN03 JPN03 JPN03 JPN03 JPN04 JPN04 JPN04 JPN04 JPN05 JPN05 JPN05 JPN05 JPN06 JPN06 JPN06 JPN06 JPN07 JPN07 JPN07 JPN07 JPN08 JPN08 JPN08 JPN08 JPN09 JPN09 JPN09 JPN09 JPN10 JPN10 JPN10 JPN10 JPN11 JPN11 JPN11 JPN11 JPN12 JPN12 JPN12 JPN12 ESP00 ESP00 ESP00 ESP01 ESP01 ESP01 ESP01 ESP02 ESP02 ESP02 ESP02 ESP03 ESP03 ESP03 ESP03 ESP04 ESP04 ESP04 ESP04 ESP05 ESP05 ESP05 ESP05 ESP06 ESP06 ESP06 ESP06 ESP07 ESP07 ESP07 ESP07 ESP08 ESP08 ESP08 ESP08 ESP09 ESP09 ESP09 ESP09 ESP10 ESP10 ESP10 ESP10 ESP11 ESP11 ESP11 ESP11 ESP12 ESP12 ESP12 ESP12 SWE00 SWE00 SWE00 SWE01 SWE01 SWE01 SWE01 SWE02 SWE02 SWE02 SWE02 SWE03 SWE03 SWE03 SWE03 SWE04 SWE04 SWE04 SWE04 SWE05 SWE05 SWE05 SWE05 SWE06 SWE06 SWE06 SWE06 SWE07 SWE07 SWE07 SWE07 SWE08 SWE08 SWE08 SWE08 SWE09 SWE09 SWE09 SWE09 SWE10 SWE10 SWE10 SWE10 SWE11 SWE11 SWE11 SWE11 SWE12 SWE12 SWE12 SWE12 GBR00 GBR00 GBR00 GBR01 GBR01 GBR01 GBR01 GBR02 GBR02 GBR02 GBR02 GBR03 GBR03 GBR03 GBR03 GBR04 GBR04 GBR04 GBR04 GBR05 GBR05 GBR05 GBR05 GBR06 GBR06 GBR06 GBR06 GBR07 GBR07 GBR07 GBR07 GBR08 GBR08 GBR08 GBR08 GBR09 GBR09 GBR09 GBR09 GBR10 GBR10 GBR10 GBR10 GBR11 GBR11 GBR11 GBR11 GBR12 GBR12 GBR12 GBR12 USA00 USA00 USA00 USA01 USA01 USA01 USA01 USA02 USA02 USA02 USA02 USA03 USA03 USA03 USA03 USA04 USA04 USA04 USA04 USA05 USA05 USA05 USA05 USA06 USA06 USA06 USA06 USA07 USA07 USA07 USA07 USA08 USA08 USA08 USA08 USA09 USA09 USA09 USA09 USA10 USA10 USA10 USA10 USA11 USA11 USA11 USA11 USA12 USA12 USA12 USA EKNR Aggregate TFP Growth OECD Annual Multifactor Productivity Growth Back

70 EKNR (2015): Investment Efficiency vs. Productivity Large literature showing investment efficiency shocks matter for growth and fluctuations including Greenwood et al. (1997), Fisher (2006), Justiniano et al. (2010). Both ˆχ D and  D can reduce Trade/GDP, but have very different implications in open-economy As shown in Boileau (1999), ˆχ D shocks generate much greater output co-movement. Net export behavior differs too negative ˆχ D generates countercycle trade balance, negative ÂD does opposite. What are these shocks? Won t shedd light here, though promising for future work. Others, like Kondo and Papanikolaou (2015), microfound with financial frictions Back

71 Some of the Challenges Recent trade models often written in changes to avoid need to calibrate bilateral trade frictions. Apply to macro side? Linearizing around SS may undesirable with 20+ countries with changing GDP shares, plus big shock Difficult to find high frequency data on durables vs. nondurables consumption, etc., for many countries