Christian M. Broda

Globalization and the Gains from Variety

Since the seminal work of Krugman (1979), product variety has played a central role in models of trade and growth. In spite of the general use of love-of-variety models, there has been no systematic study of how the import of new varieties has contributed to national welfare gains in the United States. In this paper we show that the unmeasured growth in product variety from US imports has been an important source of gains from trade over the last three decades (1972-2001). Using extremely disaggregated data, we show that the number of imported product varieties has increased by a factor of four. We also estimate the elasticities of substitution for each available category at the same level of aggregation, and describe their behavior across time and SITC-5 industries. Using these estimates we develop an exact price index and find that the upward bias in the conventional import price index is approximately 1.2 percent per year. The magnitude of this bias suggests that the welfare gains from variety growth in imports alone are 2.8 percent of GDP.

Terms of trade and exchange rate regimes in developing countries

Since Friedman (1953), an advantage often attributed to flexible exchange rate regimes over fixed regimes is their ability to insulate more effectively the economy against real shocks. I use a post-Bretton Woods sample (1973-96) of seventy-five developing countries to assess whether the responses of real GDP, real exchange rates, and prices to terms-of-trade shocks differ systematically across exchange rate regimes. I find that responses are significantly different across regimes in a way that supports Friedmans hypothesis. In response to a negative terms-of-trade shock, countries with fixed regimes experience large and significant declines in real GDP, and the real exchange rate depreciates slowly and by means of a fall in prices. Countries with more flexible regimes, by contrast, tend to have small real GDP losses and immediate large real depreciations. The contributions of terms-of-trade disturbances to the actual fluctuation of real GDP, real exchange rates, and prices are also examined.

Variety Growth and World Welfare

Economists since John Richard Hicks have known that one of the principal means, if not the principal means, through which countries benefit from international trade is by the expansion of varieties. The seminal work of Paul R. Krugman (1979) brought the study of varieties into sharp focus by presenting a simple generalequilibrium model in which countries gain from trade through the import of new varieties. Since then, economists have been hampered in their ability to quantify the impact of new varieties on national welfare by the econometric and data hurdles that need to be surmounted. In this paper, we document some stylized facts about the growth in global varieties which suggest that there may have been substantial welfare gains through the import of new varieties. Moreover, we calculate the impact of increased variety on import prices and find that conventional measures of import price inflation may be dramatically biased upward. Classical international-trade theory postulates that the elimination of trade barriers improves welfare by reducing the wedge between domestic and import prices as well as the ensuing deadweight loss. An entirely different reason for the gains from trade arises from models of monopolistic competition. If consumers value variety and countries cannot produce all varieties due to a fixed cost in the production of each variety, countries stand to gain from trade because it expands the set of available varieties. In these models, the gains hinge crucially on a number of parameters and variables. The first is the elasticity of substitution among varieties. If varieties are highly substitutable, as might be true for varieties of gasoline, then increasing the number of varieties is unlikely to have much of an effect on prices and welfare. Second, quality variation across varieties may matter. Presumably, most Americans care more about having access to French red wine than to Japanese red wine. Finally, import quantities matter as, ceteris paribus, one cares more about variety growth in big sectors than in small sectors. In Broda and Weinstein (2004), we carefully estimate the impact of increased variety in the United States over the period from 1972 to 2001. Using the most disaggregated import data available, we document that the number of varieties imported by the United States, defined as the number of import categories multiplied by the average number of source countries for each category, quadrupled. About half of this increase was due to increases in the number of categories and half due to a doubling of the number of countries from which the United States imported each good. Measuring the impact of this increase on U.S. import prices and welfare is a complex process that we will only discuss briefly here. Essentially, we used Robert C. Feenstra’s (1994) methodology to estimate 30,000 elasticities and then construct an aggregate price index that is robust to common changes in quality variation, the arbitrary splitting of categories, the introduction of new goods, and a host of other data problems. After reconstructing the U.S. import price index, we found that the price of U.S. imports has been falling at a rate 1.2 percent per year faster than one would have thought without taking new varieties into account. To get some sense of the enormity of this bias, consider that the impact of quality adjustments on the consumer price index is estimated to be 0.6 percent per year. Using this adjusted import price index, we estimate the impact of new imported varieties on * Broda: Research Department, Federal Reserve Bank of New York, 33 Liberty Street, New York, NY 10045; Weinstein: Economics Department, Columbia University, 420 W. 118th Street, New York, NY 10027, and NBER. We thank Joshua Greenfield for excellent research assistance. We thank Robert Feenstra and Peter Klenow for excellent comments. 1 “The extension of trade does not primarily imply more goods ... the variety of goods available is (also) increased, with all the widening of life that that entails. There can be little doubt that the main advantage that will accrue to those with whom our merchants are trading is a gain of precisely this kind ... . This is a gain which ‘quantitative economic history,’ which works with index numbers of real income, is ill-fitted to measure, or even to describe” (Hicks, 1969 p. 56).

Happy News from the Dismal Science: Reassessing the Japanese Fiscal Policy and Sustainability

We analyze fiscal policy and fiscal sustainability in Japan using a variant of the methodology developed in Blanchard (1990). We find that Japan can achieve fiscal sustainability over a 100-year horizon with relatively small changes in the tax-to-GDP ratio. Our analysis differs from more pessimistic analyses in several dimensions. First, since Japanese net debt is only half that of gross debt, we demonstrate that the current debt burden is much lower than is typically reported. This means that monetization of the debt will have little impact on Japans fiscal sustainability because Japans problem is the level of future liabilities not current ones. Second, we argue that one obtains very different projections of social security burdens based on the standard assumption that Japans population is on a trend towards extinction rather than transitioning to a new lower level. Third, we demonstrate that some modest cost containment of the growth rate of real per capita benefits, such as cutting expenditures for shrinking demographic categories, can dramatically lower the necessary tax burden. In sum, no scenario involves Japanese taxes rising above those in Europe today and many result in tax-to-GDP ratios comparable to those in the United States.

Endogenous Deposit Dollarization

This paper explores sources of deposit dollarization unrelated to standard moral hazard arguments.We argue that the equal treatment of peso and dollar claims on a bank in the event of default can induce banks to attract dollar deposits above the socially desirable level. The distortion arises because dollar depositors are the only source of default risk in the model, but they share the burden of the default with peso depositors as interest rates cannot be set contingent to the (unobserved) level of deposit dollarization. The incentive to dollarize is reinforced by common banking system safety nets such as deposit and bank insurance. Our findings suggest that regulators in bi-currency economies should depart from the currency-blind benchmark and instead distinguish across currencies in a way that prevents undesirable currency mismatches, even in the absence of moral hazard related to the relaxation of market discipline.

Optimal Tariffs: The Evidence

The theoretical debate over whether countries can and should set tariffs in response to export elasticities goes back over a century to the writings of Edgeworth (1894) and Bickerdike (1907). Despite the optimal tariff arguments centrality in debates over trade policy, there exists no evidence about whether countries actually apply it when setting tariffs. We estimate disaggregate export elasticities and find evidence that countries that are not members of the World Trade Organization systematically set higher tariffs on goods that are supplied inelastically. The result is robust to the inclusion of political economy variables and a variety of model specifications. Moreover, we find that countries with higher aggregate market power have on average higher tariffs. In short, we find strong evidence in favour of the optimal tariff argument.

Defining Price Stability in Japan: A View from America

Japanese monetary and fiscal policy uses the consumer price index as a metric for price stability. Despite a major effort to improve the index, the Japanese methodology of calculating the CPI seems to have a large number of deficiencies. Little attention is paid in Japan to substitution biases and quality upgrading. This implies that important methodological differences have emerged between the U.S. and Japan since the U.S. started to correct for these biases in 1999. We estimate that using the new corrected U.S. methodology, Japans deflation averaged 1.2 percent per year since 1999. This is more than twice the deflation suggested by Japanese national statistics. Ignoring these methodological differences misleading suggests that American real per capita consumption growth has been growing at a rate that is almost 2 percentage points higher than that of Japan between 1999 and 2006. When a common methodology is used Japans growth has been much closer to that of the U.S. over this period. Moreover, we estimate that the bias of the Japanese CPI relative to a true cost-of-living index is around 2 percent per year. This overstatement in the Japanese CPI in combination with Japans low inflation rate is likely to cost the government over 69 trillion yen -- or 14 percent of GDP -- over the next 10 years in increased social security expenses and debt service. For monetary policy, the overstatement of inflation suggests that if the BOJ adopts a formal inflation target without changing the current CPI methodology a lower band of less than 2 percent would not achieve its goal of price stability.

Uncertainty, Exchange Rate Regimes, and National Price Levels

Large differences in national price levels exist across countries. In this paper, I develop a general equilibrium model predicting that these differences should be related to countries’ exchange rate regimes. My empirical findings confirm that countries with fixed exchange rate regimes have higher national price levels than countries with flexible regimes. At the disaggregate level, the relationship between exchange rate regimes and national price levels is stronger for nontraded goods than for traded goods. I also find that measuring the misalignment in national price levels around times of regime shifts without considering a break in its equilibrium value results in the overestimation of the true misalignment.

Advanced Emerging Markets - a Reassessment of an Asset Class

Emerging economies may not have fully decoupled, but global influence has moved from the slow-growing G7 to booming China contributing to EM growth outperformance. And most EM weathered the crisis remarkably well despite some initial scepticism. Behind this success lie two fundamental developments: 1) Gains in monetary policy credibility; and 2) fiscal consolidation, and reduced external vulnerability. As a result, emerging economies enjoyed unprecedented room for countercyclical policies for the first time since the inception of the asset class. These policy gains are likely to be permanent: while the crisis cast doubt on the myth of self-adjusting free markets, it showed the merits of solid fiscal and monetary policies.