Povilas Lastauskas (Queen Mary University of London) - Trade Persistence Heterogeneity

BOFIT Seminar - Povilas Lastauskas (Queen Mary University of London) - Trade Persistence Heterogeneity

Co-authors: Mariarosaria Comunale (International Monetary Fund) and Justas Dainauskas (London School of Economics and Political Science)

Abstract:

International trade flows are volatile and imbalanced. We develop a theory of shared history, which generates autocorrelated bilateral trade flows that are heterogeneous across different country pairs. Our framework gives rise to a dynamic gravity equation that nests popular alternatives in the literature, namely a homogeneous parameter dynamic version with zero aggregate trade imbalances and a popular static gravity model. Not only does our model improve the accuracy of trade flow predictions, but it is also consistent with the empirically relevant declines and rapid recoveries of trade flows in response to shocks, thereby escaping what we call the "trade persistence puzzle". We also show that small asymmetries in the shared history externality across countries are sufficient to create bilateral and multilateral trade imbalances endogenously, which are important both theoretically and empirically.

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