Over the last half century the world economy has become more integrated in a number of dimensions: International trade has grown much faster than world output. Foreign assets constitute a growing share of portfolios. Countries rely more on international pools of saving to finance investment and government deficits. Because data on imports and exports are readily available and can be analyzed in a static framework, the first form of integration has been analyzed in greatest depth. In previous work the investigators developed a quantitative general equilibrium model of international trade that can incorporate substantial detail about individual countries and the geographic barriers that separate them. Because complex dynamic considerations are involved, investigation into financial integration remains much more primitive. Models have only two or three countries whose representation is very stylized. Hence they are incapable of incorporating the rich variety displayed in the data. This research builds a rich multicountry dynamic framework that integrates time into the static framework that the investigators developed in their previous work. The research has three components. The first incorporates trade imbalances to assess the impact of current account reversals on exchange rates, welfare, and income distribution within and across countries. A key policy question that the research addresses is the impact that a likely reversal of the U.S. current account deficit will have in the United States and abroad. The outcome reflects (i) adjustment in the set of goods that are traded (the extensive margin), (ii) the mobility of labor and other factors of production between traded and nontraded activities, and (iii) the role of geography in adjustment. With little ability to adjust, the relative GDP changes across countries associated with achieving current account rebalancing are large. Because of the pervasiveness of nontradability, the effect of exchange rate changes on standards of living is more modest. The second component introduces intertemporal maximization. The static framework is extended to allow for differences in factor endowments, technology, and trade barriers over time as well as across countries. Countries trade intertemporally to accommodate shocks. But this trade is costly in terms of the resources absorbed by geographic barriers. Calculations indicate that trade barriers of the magnitude implied by static gravity models impede consumption smoothing by amounts consistent with that observed in the data. The third component examines investment as well as consumption. Results indicate that geographic barriers can explain the high (but declining) correlation of savings and investment. The analysis provides a deeper understanding of the determinants and consequences of long-run swings in countries' trade balances. This research furthers economists' ability to model quantitatively a dynamic, multi-country world. It connects two literatures, the static modeling of trade flows and dynamic open-economy macroeconomics. The framework it develops can be used to address a host of key issues in international economic policy.
