Paper #1503

Title:

Global imbalances revisited: The transfer problem and transport costs in monopolistic competition

Authors:

Paolo Epifani and Gino Gancia

Date:

December 2015 (Revised: February 2017)

Abstract:

We study the welfare effects of trade imbalances in a two-sector model of monopolistic competition. As in perfect competition, a trade surplus involves an income transfer to the deficit country and possibly a terms-of-trade deterioration. Unlike the conventional wisdom, however, trade imbalances do not impose any double burden on surplus countries. This is because of a production-delocation effect, which leads to a reduction in the local price index. In the presence of intermediate goods, new results arise: A trade surplus may lead to an appreciation of the exchange rate, to a terms-of-trade improvement and even to a welfare increase. Numerical simulations show that, under realistic assumptions about preferences and technology, the beneficial price-index effect can significantly reduce the direct cost of the transfer.

Keywords:

Trade Imbalances; Trade Costs; Monopolistic Competition; Intermediate Goods.

JEL codes:

F1

Area of Research:

Macroeconomics and International Economics

Comment:

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