obstfeld+_2000_nber_six_major_puzzles_of_international_macroeconomics_is_there_a_common_cause Obstfeld, M. Rogoff, K. 2000

The six major puzzles:

  1. Home-bias in trade
  2. Why do observed OECD current-account imbalances tend to be so small relative to saving and investment when measured over any sustained period (the Feldstein-Horioka puzzle). Cross section regressions of investment on saving (by F and H) yielded slope coeffiecients near unity. In a world of fully integrated capital markets one would expect global savings should flow to the regions with highest rate of return.
  3. Why do home investors overwhelmingly prefer to hold home equity assets (the home-bias portfolio puzzle)
  4. Why isn't consumption more highly correlated across OECD countries (the consumption correlations puzzle)
  5. The Purchasing-Power-Parity puzzle (see [Rogoff JEL 1996])
  6. Why are exchange rates so volatile and so apparently disconnected from fundamentals (the exchange-rate disconnect puzzle)
What we attempt to do in this paper is to offer a unified basis for understanding all of these puzzles, in which the key friction is a (significant but plausible) level of international trade costs in goods markets. These trade costs may include transport costs but also tariffs, nontariff barriers, and possibly other broader factors that impede trade.

Home Bias:

With simple model derive: Ratio of expenditure on home vs foreign goods = (1-tau) ^ (1-theta)
( Ch / p Cf = (1-tau)1-theta )
  • Summary of literature on value of elasticity of import demand with respect to price (theta): around 6 for traded goods (large ranges: 6-12 and bigger)
  • Summary of literature on estimates of trade costs (tau): Average tariffs (on weighted basis) were 4.9% (US), 7.7% (EU), 3.5% Japan, 8.9% Canada. Non-tariff barrier costs are estimated to be roughly of same size as for tariffs (citing Andersen and Neary 1998). Freight and insurance charges averaged 3.3% (1996-7) and 3.6% (1995) for US imports (this does not take into account other costs such as paperwork, spoilage etc) and this is probably lower than for most other countries.

Feldstein-Horioka

  1. Do their own quick f-h regression. I/Y = a + b * NS/Y (NS is national savings) for OECD 1990-7. This yields coefficient of b = 0.60. Lower than f-h original 0.89 but still substantial
  2. How do they solve the problem? By introducing trade costs they show that the effective domestic interest rate and world interest rate (fixed) may diverge heavily. Domestic interest rate moving in opposite direction to current account surplus. Since return received from investing abroad (running current account surplus) is this effective interest rate this can account for low investment abroad (actual returns are much lower than apparent returns. The changes in interest rate derive from changes in relative price of goods. (???)

  3. PPP Puzzle

    See Rogoff JEL 1996. Puzzle is this:
    1. FACT 1: very slow reversion to trend for real exchange rate (formally is q(t) is log real exchange rate then: q(t) = a + b*t + c * q(t-1) + eps(t) yields coefficient of c very close to 1 (0.97-0.99) ). Half life for a disturbance is 3-4 years.
    2. FACT 2: degree of short term volatility in nominal exchange rate (and therefore real exchange rate as price level fixed in v. short term) is so high that it can only come from financial/monetary (i.e. nominal) shocks.
    Combined these 2 facts give the puzzle: if shocks are coming from nominal disturbances why do they take so long to die away?