Expectation‐driven fluctuations and welfare loss under free trade in two‐country models

Abstract

This paper investigates the interlinkage in the business cycles based on expectation‐driven fluctuations of large‐country economies in a free‐trade equilibrium. We consider a two‐country, two‐good, two‐factor general equilibrium model with sector‐specific externalities. We show that some country's expectation‐driven fluctuations can spread throughout the world once trade opens even if the other country has determinacy under autarky. We thus prove that under free trade, globalization and market integration can have destabilizing effects on a country's competitive equilibrium. Finally, we characterize a configuration in which opening to international trade improves the stationary welfare at the world level but deteriorates the stationary welfare of the country that imports investment goods and exports consumption goods. We conclude that in opposition to the standard belief, international trade might not be beneficial to all trading partners in the long run.

International credit markets and global business cycles

“…For instance, in a perfect-foresight trade model, Nishimura and Yano (1993) compare the correlation of the endogenous real business cycles in trading countries before and after the opening up of trade. In a model with sector-specific externalities, Nishimura et al (2010) investigate the interlinkages in the business cycles of two countries and its welfare implications when self-fulfilling prophecies arise in a free-trade equilibrium. In contrast, our emphasis on global financial linkages in explaining international co-movements accords with the existence of a global financial cycle documented in particular by Miranda-Agrippino and Rey (2015), in addition to the studies using dynamic factor analysis reviewed above.…”

Macroeconomic volatility and trade in OLG economies

“…Nishimura et al . () consider an infinitely lived agent model with asymmetric technologies across countries and sector‐specific externalities. They show that trade creates a contagion of sunspot cycles from one country to another.…”

“…The second subset of models contains the contributions which deal with international capital mobility and international labor immobility. Nishimura et al (2010) consider an infinitely lived agent model with asymmetric technologies across countries and sector-specific externalities. They show that trade creates a contagion of sunspot cycles from one country to another.…”

Macroeconomic dynamics and its micro foundation: A special issue in honor of Cuong Le Van

“…A topic at the forefront of macroeconomic dynamics is expectations‐driven fluctuations (see Eusepi ; Nishimura, Venditti, and Yano ; Guo, Sirbu, and Suen ) . Stephano Bosi and Thomas Seegmuller provide new insight on this issue, characterizing a rational bubble.…”