Investment and Trade Patterns in a Sticky-Price, Open-Economy Model
This paper explores a two-country DSGE model with sticky prices à la Calvo (1983) and local-currency pricing. We analyze the investment decision in the presence of adjustment costs of two types, i.e., capital adjustment costs (CAC) and investment adjustment costs (IAC). We compare the investment and trade patterns with adjustment costs against those of a model without adjustment costs and with (quasi-) flexible prices. We show that having adjustment costs results into more volatile consumption and net exports series, and less volatile investment. We document three important facts on US trade dynamics: (1) the S-shaped cross-correlation between real GDP and the real net exports share, (2) the J-curve between terms of trade and net exports, and (3) the weak and S-shaped cross-correlation between real GDP and terms of trade. We find that adding adjustment costs tends to reduce the model’s ability to match these stylized facts. Nominal rigidities cannot account for these features either.
KeywordsReal Exchange Rate Adjustment Cost Contemporaneous Correlation Nominal Rigidity Sticky Prex
We would like to thank Mark Wynne, Roman Sustek, Finn Kydland and Carlos Zarazaga for many helpful discussions. We also acknowledge the support of the Federal Reserve Bank of Dallas and the Bank of England. However, the views expressed in this chapter do not necessarily reflect those of the Federal Reserve Bank of Dallas, the Federal Reserve System or the Bank of England. All errors are ours alone.
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