Macroeconomics: A Unified Model of International Business Cycles and Trade

Abstract

We present a general, competitive open economy business cycles model with cap-ital accumulation, trade in intermediate goods, production externalities in the inter-mediate and final goods sectors, and iceberg trade costs. Our main theoretical result shows that under appropriate parameter restrictions this model is isomorphic in terms of aggregate equilibrium predictions to dynamic versions of workhorse quantitative models of international trade: Eaton-Kortum, Krugman, and Melitz. The parameter restrictions apply on the overall scale of externalities, the split of externalities between factors of production, and the identity of sectors with externalities. Our quantitative exercise assesses whether various restricted versions of the general model — in forms they are typically considered in the literature — are able to resolve well-known aggre-gate empirical puzzles in the international business cycles literature. Our theoretical result on isomorphism between models provides insights on why dynamic versions of international trade models fail to resolve these puzzles in so many instances. We then additionally explore in what directions they need to be amended to provide a better fit with the data. We show that an essential feature is negative capital exter-nalities in intermediate goods production. We thus provide a unified theoretical and quantitative treatment of the international business cycles and trade literatures in a general dynamic framework.

Key words: International business cycles; Dynamic trade models; Heterogeneous firms; Production externalities; Monopolistic competition; Export costs; Entry costs