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Trade costs and the open macroeconomy

By Dennis Novy

Abstract

Trade costs are known to be a major obstacle to international economic integration. Following the approach of New Open Economy Macroeconomics, this paper explores the effects of international trade costs in a micro-founded general equilibrium model that also allows for pricing to market. Trade costs are shown to create an endogenous home bias in consumption and reduce cross-country consumption correlations. In addition, trade costs magnify exchange rate volatility in response to monetary shocks and typically turn a monetary expansion into a beggar-thy-neighbor policy. It is striking that trade costs generally lead to these results both under producer and local currency pricing

Topics: HF
Publisher: University of Warwick, Department of Economics
Year: 2006
OAI identifier: oai:wrap.warwick.ac.uk:1422

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