Liu, Xuan (2007): Trade Openness and the Cost of Sudden Stops: The Role of Financial Frictions.
This is the latest version of this item.
Download (326kB) | Preview
This paper analyzes the trade policy when country spread becomes more volatile due to the possibility of sudden stops. Both analytical and numerical results show that sudden stops have weaker output impact when the small open economy is more open to trade; however, this does not imply the optimality of an open trade policy. When the economy does not pay additional expenses to adjust its foreign debt, the cost of sudden stops is decreasing in trade openness, which implies the optimality of an open trade policy. In this case, external shocks may be welfare improving. The economy will gain from counter-cyclical tariff rate policies. On the other hand, when the economy has to pay additional expenses to adjust its foreign debt, a closed trade policy is optimal. In this latter case, the nature of the policy and how the government implements the policy matter. The results hold in economies with and without the working capital constraint, and in both economies with GHH preferences and those with Cobb-Douglas preferences.
|Item Type:||MPRA Paper|
|Original Title:||Trade Openness and the Cost of Sudden Stops: The Role of Financial Frictions|
|Keywords:||Trade openness; Welfare cost; Sudden stops; Small open economy; Second order approximation.|
|Subjects:||F - International Economics > F3 - International Finance > F34 - International Lending and Debt Problems
E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles
G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets
F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics
E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E61 - Policy Objectives ; Policy Designs and Consistency ; Policy Coordination
|Depositing User:||Xuan Liu|
|Date Deposited:||26. Nov 2009 01:57|
|Last Modified:||24. Mar 2015 22:04|
Aguiar, M. and G. Gopinath, 2007. Emerging market business cycles: The cycle is the trend, Journal of Political Economy, 115, 69-102.
Bacchetta, P. and E. Wincoop, 2000. Does exchange-rate stability increase trade and welfare? American Economic Review, 90(5), 1093-1109.
Backus, D. K., P. J. Kehoe, and F. E. Kydland, 1992. International real business cycles, Journal of Political Economy, 100(4), 745-775.
Bagwell, K. and R. W. Staiger, 1995. Protection and the business cycle, Advances in Economic Analysis & Policy, Berkeley Electronic Press.
Bagwell, K. and R. W. Staiger, 1999. An economic theory of GATT." American Economic Review, 89(1): 215-248.
Barro, R. J., 2009. Rare disasters, asset prices, and welfare costs. American Economic Review 99 (1), 243-264.
Bernanke, B. S., M. Gertler, and S. Gilchrist, 1999. The Financial Accelerator in a Quantitative Business Cycle Framework, in J.B. Taylor and M. Woodford, eds., Handbook of Macroeconomics, vol. 1C, Amsterdam: North-Holland.
Broda, C., N. Limao, and D. E. Weinstein, 2008. Optimal tariffs and market power: The evidence." American Economic Review, 98(5): 2032-2065.
Calvo, G., 1998. Capital flows and capital-market crises: The simple economics of sudden stops, Journal of Applied Economics 1(1), 35-54.
Calvo, G. A., A. Izquierdo, and L. F. Mejia, 2004. On the empirics of sudden stops: the relevance of balance-sheet effects, NBER Working Paper No. 10520.
Calvo, G. A. and E. Talvi, 2005. Sudden stop, financial factors and economic collapse in Latin America: Learning from Argentina and Chile, NBER Working Paper No. 11153.
Calvo, G.A. and Vegh, C.A., 1993. Exchange-rate-based stabilization under imperfect credibility. H. Frisch and A. Worgotter (eds.) Proceedings from IEA Conference on Open Economy Macroeconomics, England: Macmillan Press Ltd., 3-28.
Chari, V.V., P. Kehoe, and E. R. McGrattan, 2005. Sudden stops and output drops, American Economic Review, 95(2), 381-387.
Cho, J. O. and T. F. Cooley, 2005. Business cycle uncertainty and economic welfare. New York University working paper.
Deaton, A., and R. Miller, 1996. International commodity prices, macroeconomic performance and politics in Sub-Saharan Africa, Journal of African Economies 5(3), 99-191.
Demir, F., 2007. Volatility of short term capital flows and sociopolitical instability in devel- oping countries: A review, MPRA Working Paper.
den Hann, W., and J. de Wind, 2008. Punishment functions. Mimeo, University of Amster- dam.
Dolmas, J., 1998. Risk preferences and the welfare cost of business cycles. Review of Economic Dynamics, 1, 646-676.
Easterly, W., R. Islam, and J. E. Stiglitz, 2001. Shaken and stirred: Explaining growth volatility, in B. Pleskovic and N. Stern, eds., AnnualWorld Bank Conference on Development Economics.
Edwards, S., 2004a. Financial openness, sudden stops and current account reversals, American Economic Review, 94, 59-64.
Edwards, S., 2004b. Thirty years of current account imbalances, current account reversals and sudden stops, NBER Working Paper No. 10276.
Ehrlich I., and G. S. Becker, 1972. Market insurance, self-insurance, and self-protection, Journal of Political Economy, 80(4), 623-648.
Ericson, R. and X. Liu, 2009. Welfare effect of interest rate volatility. East Carolina Uni- versity, working paper.
Faia, E., and T. Monacelli, 2007. Optimal interest-rate rules, asset prices, and credit frictions, Journal of Economic Dynamics and Control, 31: 3228-3254.
Fatas, A. and I. Mihov, 2005. Policy volatility, institutions and economic growth, CEPR Discussion Paper No. 5388.
Federer, J., 1993. The impact of uncertainty on aggregate investment spending, Journal of Money, Credit and Banking, 25(1), 30-48.
Frankel, J. A. and E. A. Cavallo, 2004. Does openness to trade make countries more vulnerable to sudden stops, or less? Using gravity to establish causality, NBER Working Paper No. 10957.
Garcia, J., R. Pancrazi, and M. Uribe, 2009. Real business cycles in emerging economies? American Economic Review, forthcoming.
Giovanni, J. and A. A. Levchenko, 2006. Openness, volatility, and risk content of exports, Society for Economic Dynamics 2006 Meeting Papers no. 86.
Greenwood, J., Z. Hercowitz, and G. Huffman, 1988. Investment, capital utilization, and the real business cycles, American Economic Review, 96, 921-947.
Haltiwanger, J., A. Kugler, M. Kugler, A. Micco and C. Pag, 2004. Effects of tariffs and real exchange rates on job reallocation: Evidence from Latin America, Journal of Policy Reform, 7(4), 191-208.
Hau, H., 2002. Real exchange rate volatility and economic openness: Theory and evidence, Journal of Money, Credit and Banking, 34(3), 611-630.
Hnatkovska, V., and N. Loayza, 2005. Volatility and Growth, in Managing Volatility, edited by Joshua Aizenmann and Brian Pinto, Cambridge University Press, 65-100.
Hoffmaister, A., J. Roldos, and P. Wickham, 1998. Macroeconomic fluctuations in Sub- Saharan Africa, International Monetary Fund Sta® Paper 45(1).
Jahan-Parvar, M. R., X. Liu, and P. Rothman, 2009. Equity returns and business cycles in small open economies. East Carolina University, Working paper.
Kollmann, R., 2002. Monetary policy rules in the open economy: Effects on welfare and business cycles, Journal of Monetary Economics, 49, 989-1015.
Kim, J., and S. H. Kim, 2003. Spurious Welfare Reversals in International Business Cycle Models, Journal of International Economics, Vol. 60(2), 471-500.
Kim, J., S. H. Kim, and A. Levin, 2003. Patience, persistence, and welfare cost of incomplete markets in open economies, Journal of International Economics, 61, 385-396.
Loayza, N. and C. Raddatz, 2006. The structural determinants of external vulnerability, World Bank Policy Research Working Paper, No. 4089.
Loayza, N., R. Ranciere, L. Serven, and J. Ventura, 2007. Macroeconomic volatility and welfare in developing countries: An introduction, The World Bank Economic Review, 21(3), 343-357.
Lucas, R. E., 1987. Models of Business Cycles. New York: Basil Blackwell.
Mas-Colell, A., M. D. Whinston, and J. R. Green, 1995. Microceconomic Theory. Oxford University Press.
Mendoza, E. G., 1991. Real business cycles in a small open economy, American Economic Review, 81(4), 797-818.
Mendoza, E. G., 1995. The terms of trade, the real exchange rate and economic fluctuations, International Economic Review, 36, 101-137.
Mendoza, E. G., 2001. Credit, prices and crashes: Business cycles with a sudden stop, NBER Working Paper No. 8338.
Mendoza, E. G. and K. A. Smith, 2002. Margin calls, trading costs, and asset prices in emerging markets: The financial mechanics of the 'sudden stop' phenomenon, NBER Working Paper No. 9286.
Mendoza, E. G. and K. A. Smith, 2006. Quantitative implications of a debt-deflation theory of Sudden Stops and asset prices, Journal of International Economics, 70(1), 82-114.
Mendoza, E. G. and M. Uribe, 1999. The business cycles of balance of payment crises: A revision of a Mundellian framework, NBER Working Paper No. 7045.
Mendoza, E. G. and M. Uribe, 2000. Devaluation risk and the business-cycle implications of exchange-rate management, Carnegie-Rochester Conference Series on Public Policy, 53, pp. 239-296.
Mulraine, M. L. B., 2004. Investment specific technology shocks to a small open economy, MPRA Paper.
Neumeyer, P. A. and F. Perri, 2001. Business cycles in emerging economies: The role of interest rates. Working Papers 01-12, New York University, Leonard N. Stern School of Business, Department of Economics.
Neumeyer, P. A. and F. Perri, 2005. Business cycles in emerging economies: The role of interest rates, Journal of Monetary Economics, 52(2), 345-380.
Obstfeld, M. and K. Rogoff, 2000. New directions for stochastic open economy models, Journal of International Economics, 50(1), 117-153.
Ostry, J. D. and C. M. Reinhart, 1992. Private saving and terms of trade shocks: Evidence from developing countries, IMF Staff Papers No. 91/100.
Otrok, C., 2001. On measuring the welfare cost of business cycles, Journal of Monetary Economics, 47, 61-92.
Pallage, S. and M. A. Robe, 2003. On the welfare cost of economic fluctuations in developing countries, International Economic Review, 44(2), 677-698.
Raddatz, C., 2006. Liquidity needs and vulnerability to financial underdevelopment, Journal of Financial Economics. 80(3), pages 677-722.
Ramey, G., and Ramey, V. A., 1995. Cross country evidence on the link between volatility and growth, American Economic Review, 85(5), 1138-1151.
Rebelo, S. and C. A. Vegh, 1995. Real effects of exchange rate based stabilization: An analysis of competing theories, NBER Working Papers No. 5197.
Reinhart, C. M. and C. A. Vegh, 1994. Inflation stabilization in chronic inflation countries: The empirical evidence. Mimeo, Research Department, International Monetary Fund.
Rodrik, D., 1997. Has globalization gone too far? Washington, D.C.: Institute for International Economics.
Rodrik, D., 1998. Why do more open economies have bigger governments? Journal of Political Economy, 106 (5), 997-1032.
Schmitt-Grohe, S. and M. Uribe, 2001. Stabilization policy and the costs of dollarization, Journal of Money, Credit, and Banking, 33, 482-509.
Schmitt-Grohe, S. and M. Uribe, 2003. Closing small open economy, Journal of International Economics, 61, 163-185.
Schmitt-Grohe, S. and M. Uribe, 2004. Solving dynamic general equilibrium models using a second-order approximation to the policy function. Journal of Economic Dynamics and Control, 28, 755-775.
Schmitt-Grohe, S. and M. Uribe, 2006a. Optimal simple and implementable monetary and fiscal rules: Expanded version, NBER Working Paper No. 12402.
Schmitt-Grohe, S. and M. Uribe, 2006b. Optimal Fiscal and Monetary Policy in a Medium-Scale Macroeconomic Model, in Gertler, Mark and Kenneth Rogoff, eds., NBER Macroeconomics Annual 2005, MIT Press: Cambridge MA, 2006, 383-425
Schmitt-Grohe, S. and M. Uribe, 2007. Optimal simple and implementable monetary and fiscal rules, Journal of Monetary Economics, 54, 1702-1725.
Turnovsky, S. J., 1993. The impact of terms of trade shocks on a small open economy: A stochastic analysis, Journal of International Money and Finance, 12(3), 278-297,
Uribe, M. and V. Z. Yue, 2006. Country spreads and emerging countries: Who drives whom? Journal of International Economics, 69(1), 6-36.
Available Versions of this Item
Trade Openness and the Cost of Sudden Stops: The Role of Financial Friction. (deposited 01. Nov 2009 14:40)
- Trade Openness and the Cost of Sudden Stops: The Role of Financial Frictions. (deposited 26. Nov 2009 01:57) [Currently Displayed]