Trade costs, trade balances and current accounts: An application of gravity to multilateral trade

Giorgio Fazio, Ronald MacDonald, Jacques Melitz

    Research output: Contribution to journalArticle

    5 Citations (Scopus)

    Abstract

    In this paper we test the well-known hypothesis of Obstfeld and Rogoff (NBER Macroeconomics Annual 7777:339-390, 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 econometric 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. © Springer Science+Business Media, LLC 2008.

    Original languageEnglish
    Pages (from-to)557-578
    Number of pages22
    JournalOpen Economies Review
    Volume19
    Issue number5
    DOIs
    Publication statusPublished - 2008

    Keywords

    • Current account
    • Feldstein-Horioka puzzle
    • Gravity model
    • Home bias puzzle
    • Trade balance
    • Trade costs

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