Academic journal article International Advances in Economic Research

The Intertemporal Equilibrium Modeling of Intra-EMU and Global Trade Imbalances

Academic journal article International Advances in Economic Research

The Intertemporal Equilibrium Modeling of Intra-EMU and Global Trade Imbalances

Article excerpt

Abstract The intertemporal equilibrium approach to current accounts analyzed the impacts of respective intra-European Monetary Union (intra-EMU) and Asian-U.S. financial integration between 1999 and 2007 on the intra-EMU current account and global trade imbalances. Moreover, Farmer and Ban (2014) find in a three-country, two-region overlapping generations model that financial integration between both the EMU core and periphery and between Asia and the U.S. induce trade surpluses in the EMU core and Asia, while in the EMU periphery and in the U.S., trade balances become negative when the global economy is dynamically inefficient. In this paper, we first show that in a numerically specified Farmer-Ban model, steady-state trade balance to gross domestic product ratios are too low compared to the empirically observed counterparts. We suggest avenues to ameliorate this problem.

Keywords Trade imbalances * European economic and monetary union * Overlapping generations * Three-country model ? Global imbalances

JEL F36

Introduction and Motivation

The well-known intertemporal approach to the current account (Obstfeld and Rogoff 1995) based on the seminal contributions of Sachs (1981) and Buiter (1981) was rather successfully used to analyze the impacts of the intra-European Monetary Union (EMU) (core, periphery) and Asian-U.S. financial integrations, respectively, on the intra-EMU current account (e.g. Ca'Zorzi and Rubaszek 2012; Farmer 2014) and global (Asia and the U.S.) trade imbalances (e.g. Eugeni 2015). Because these studies investigate the emergence of intra-EMU and global external imbalances isolated from each other with two-country intertemporal equilibrium models, Farmer and Ban (2014) constructed a three-county overlapping generations (OLG) model a la Buiter (1981) to explore the effects of simultaneous financial integration within the EMU and between Asia and the U.S. on the widening of current account and trade imbalances between 1999 and 2008. Farmer and Ban (2014) find that financial integration between both the EMU core and periphery and between Asia and the U.S. induce current account and trade surpluses in the EMU core and Asia, but in the EMU periphery and the U.S., both balances become negative when the global economy is dynamically inefficient. In this paper, we try to verify quantitatively the qualitative results of Farmer and Ban (2014) within a numerically specified version of the three-country OLG model. In comparing the model- generated trade imbalances (as a percent of countries' gross domestic product [GDP] to their empirically observed counterparts, we evaluate the capability of the three-country model to reproduce the data. Since the basic model generates too low steady state trade imbalance to GDP ratios compared to the empirically observed ones, we investigate several extensions of the basic model to address this problem.

In order to motivate the set-up of the basic model and its extensions, we recall key stylized facts regarding intra-EMU and global external imbalances between the late 1990s and the onset of the global financial crisis in 2007. First, while Euro-related financial integration and convergence expectations (Blanchard and Giavazzi 2002; Lane 2006; Spiegel 2009; Kalemli-Ozcan et al. 2010; Schmitz and Hagen 2011) contributed without doubt to the evolution of intra-EMU external imbalances, Chen et al. (2013) emphasize extra-EMU factors as first, the increasing competitive advantage of Asian exporters vis-a-vis EMU periphery exporters, second, the rising demand for EMU core capital goods from Asia and oil exporters and last, the U.S. demand for EMU core financial assets. As a consequence, the EMU periphery's current account deficit, while financed mostly by capital inflows from the EMU core, did not increase vis-a-vis the core but instead vis-a-vis Asia and oil exporters. Similarly, the EMU core's current account surplus after the Euro launch resulted not from the EMU periphery's imports but from rising Asian imports of EMU core (capital) goods. …

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