Puzzles in international
macroeconomics
Six major puzzles in international
macroeconomics: search for a common
cause
• Obsteld M. and K. Rogoff, The Six Major Puzzles in
International Macroeconomics: Is There a Common
Cause?, 2000, NBER Working paper 7777.
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Home bias in trade
Saving-investment puzzle
Equity home bias
Consumption correlation puzzle
Purchasing Power Parity
Exchange rate disconnect
By explicitly introducing trade costs,
one can go far toward explaining a
great number of the main empirical
puzzles.
Trade costs may include
transportation costs, tariffs, nontariff barriers
Home bias in trade
• International markets are more segmented
then is commonly supposed
• There is a substantial border effect that
reduce cross-country trade
• How big is the border effect? Can the
market segmentation be explained by
trade costs of the reasonable size?
How big is the border effect?
•
McCallum 1996, National Borders Matter: Canada-US regional trade
patterns, American Economic Review 85, pp. 615-623
Estimated the gravity equation where the dependent variable Xji is exports from each
Canadian province to other provinces or to the US states:
ln X ji    1 ln Y i  2 ln Y j   ij   ln d ij   ij
where  ij is an indicator variable that equals unity for trade between two Canadian
provinces and zero otherwise
Trade across individual Canadian
provinces was 22 times higher then
between individual Canadian provinces
and US states!
Is anything wrong with McCallum’s
estimation of the border effect
• Asymmetric effect on countries of different size
• Misspecification of the gravity equation
• Anderson and Wincoop (2003), Gravities with
Gravitas: A solution to the Border puzzle,
American Economic Review 93, pp. 170-192
– National borders reduce trade between the US and Canada by
about 44%, while reducing trade among other industrialized
countries by about 30%. McCallum's spectacular headline
number is the result of a combination of omitted variables bias
and the small size of the Canadian economy. Within-Canada
trade rises by a factor 6 due to the border. In contrast, within-US
trade rises 25%.
Asymmetric effect on countries of
different size: numerical example
• With no trade barriers, Canada exports 90% of GDP to
the US and sells 10% internally
• Suppose the border effect reduces cross-border trade by
50%
• Then, Canada imports 45% of GDP to US and trade
55% internally
• So, internal trade went up by 5.5 times, cross border
trade went down by 50%, and so internal trade has
increased by 11 times more then cross-border trade
• For US, it used to import 10% of GDP and now imports
5%. Cross-state trade has increased by 2.1 times more
then cross-border trade
Home bias in trade
Obstfeld, Rogoff 2000:
• Average size trade costs combined with high
elasticities of substitution of home for foreign
goods can account for large part of home bias
• In addition, exchange rate uncertainty and
difference in tastes across countries also leads
to higher home good consumption
Stylized model by Obstfeld and Rogoff (2000)
The ratio of home to foreign expenditures on goods is
CH
 (1   )1
pCF
p - price of foreign goods in terms of home goods
τ - trade costs
CH - expenditure on home goods
pCF - expenditure on foreign goods
 With no trade costs, C  pC , and there is no home bias in
trade
 If we assume plausible trade costs,   0.25 and elasticity of
import demand with respect to price   6 , then the
expenditure on home goods is 4.21 times higher then on
imported goods
H
F
Empirical estimates of θ
• Trefler and Lai (1999) θ=5.2
– panel of 28 industries in 36 countries for the
period 1972-1992
• Cheung, Finn, and Fujji (1999): θ=3.5-4
– monopolistic competition model
– two-digit industry level data for OECD
countries
• Hummels (1999a): θ=5.6
Empirical estimates of trade costs
Simple and Trade-Weighted Tariff Averages - 1999
Simple
Trade-weighted
Argentina
14.8
11.3
Australia
4.5
4.1
Bangladesh
22.7
21.8
Barbados
19.2
20.3
EU
3.4
2.7
Georgia
10.6 Grenada
18.9
15.7
Guyana
20.7 Honduras
7.5
7.8
India
30.1 Indonesia
11.2 Jamaica
18.8
16.7
Japan
2.4
2.9
Romania
15.9
8.3
Slovenia
9.8
11.4
Switzerland
0
0
USA
2.9
1.9
Notes: The data are from UNCTAD’s TRAINS database (Haveman
repackaging). A ”-” indicates that trade data for 1999 are unavailable in
TRAINS.
Anderson and Wincoop (2004)
Non-Tariff Barriers - 1999
Country
Argentina
Australia
Brazil
Canada
European Union
Hungary
Indonesia
Lithuania
Mexico
Poland
Romania
Slovenia
Taiwan
Tunisia
USA
Narrow
Simple
TW
0.26
0.014
0.108
0.151
0.008
0.013
0.001 0
0.002
0.001
0.001
0.03
0.057
0
0.015
0.441
0.006
0.299
0.039
0.041
0.034
0
0
0.05
0
0.019
0.074
0
0.055
Broad
Simple
TW
0.718
0.225
0.44
0.307
0.095
0.231
0.118 0.191
0.58
0.133
0.207
0.393
0.138
0.317
0.272
0.756
0.351
0.603
0.198
0.106
0.161
0.196
0.533
0.235
0.185
0.408
0.207
0.598
0.389
Notes: The data are from UNCTAD’s TRAINS database (Haveman
repackaging). The “Narrow” category includes, quantity, price, quality and
advance payment NTBs, but does not include threat measures such as
antidumping investigations and duties. The “Broad” category includes
quantity, price, quality, advance payment and threat measures. The ratios calculated based on six-digit HS
categories. A ”-” indicates that trade data for 1999 are not available.
Anderson and Wincoop (2004)
Saving-investment puzzle
• Feldstein, Martin, and Charles Horioka
(1980) “Domestic Savings and
International Capital Flows,” Economic
Journal 90 (358) June, 314-329.
• Correlation between savings and
investments in OECD countries is much
greater then predicted by economic
models
Equity home bias
• Equity home bias (Kenneth R. French; James M.
Poterba, (1991), Investor Diversification and
International Equity Markets The American
Economic Review, Vol. 81, No. 2.)
• Economic agents prefer to keep their wealth in
home assets. They diversify their portfolio less
then predicted by models of risk-sharing and are
overly optimistic about returns on home assets
• At the end of the 80th, Americans held 94
percent of their wealth in the US stock market,
whereas Japanese held 98 percent of their
equity wealth at home
Consumption correlation puzzle
• Consumption correlation puzzle (Backus,
Kehoe, and Kydland 1992, International
Real Business Cycles, Journal of Political
Economy 100, pp. 745-775 )
• International output growth rates are more
highly correlated then consumption growth
rates
Purchasing Power Parity
• Purchasing Power Parity (Rogoff, Kenneth
(1996), “The Purchasing Power Parity
Puzzle,” Journal of Economic Literature,
Vol.34, No. 2., pp. 647-668.)
• Does not hold in a short run, there are
some evidence that it holds over the long
horizon
Exchange rate disconnect
• Exchange rate disconnect (Baxter, M and
A. Stockman, 1989, Business Cycles and
Exchange Rate regime: some international
evidence, Journal on Monetary
Economics, 23, pp. 377-400)
• Weak connection between exchange rates
and virtually any macroeconomic
aggregates