Emily T. Cremers

General equilibrium with trade balance and real interest rate parity

Abstract. This paper demonstrates, in the context of a two-sector OLG neoclassical growth model, conditions under which international trade in consumption goods alone may be sufficient for the equalization of real returns to physical capital across countries; that is, under which commodity arbitrage is sufficient for real interest rate parity (RIRP). This role for repeated commodity arbitrage is established via a dynamic extension of the factor price equalization (FPE) theorem which is valid at all dates comprising the equilibrium path as well as its steady state. The results are at odds with the conventional view regarding RIRP which arises from open one-sector growth models, in which case steady state trade balance and RIRP are irreconcilable, and are also a contradiction to frequent assertions of lon-run specialization in two-sector frameworks. An equilibrium path for an integrated world economy yields an endogenous, time-variant cone of diversification which implies sufficient conditions for the dynamic paths of a cross-section of economies to exhibit FPE, and hence RIRP with trade balance, at all points in time. These conditions require that the savings rates and initial capital-labor ratios of individual countries do not deviate too significantly from world averages, and that both sectors absorb capital easily. The first of these requirements is sufficient to establish steady state FPE and RIRP in the general specification. The first two requirements are sufficient for the entire equilibrium path to be characterized by FPE and RIRP in a log-linear example.

Intergenerational Welfare and Trade

This paper examines the dynamic effects of international commodity trade by mergingtwo benchmark environments, namely, the static factor endowments model and theneoclassical growth model. Two main questions are asked. First, how does commoditytrade affect the capital-accumulation paths of two trade partners? Second, do the welfareeffects associated with these dynamics serve to reinforce or mitigate the well-knownwelfare effects associated with the static factor endowments model? It is demonstratedthat trade will eventually, if not immediately, narrow the difference in domestic capitalaccumulation paths. This narrowing introduces a negative welfare effect that is largeenough to worsen overall welfare for the country whose capital accumulation hasdeclined. Thus, although the dynamic effects of trade are large enough to dominate

Transfers, the terms of trade, and capital accumulation

The static trade literature has concluded that, absent distortions and bystanders, transfer induced movements in the terms of trade cannot be large enough (under Walrasian stability) to produce the transfer paradox. Dynamic one-sector models have argued that a transfer paradox is possible, but have relied upon international capital mobility and movements in the world interest rate rather than commodity markets and prices. In a dynamic two-sector overlapping generations model - which allows for both static and intertemporal terms of trade effects -commodity trade can produce a steady state transfer paradox under Walrasian stability, and without distortions or bystanders. The existence of the paradox is due to the effect of the transfer on world capital accumulation which is shown to always (that is, for any ranking of factor intensities and savings rates) improve the donors terms of trade. Transfers may also be Pareto-improving in the steady state, and produce paradoxical welfare results along the transition path.

Transfers, the Terms of Trade and Capital Accumulation

The static trade literature has concluded that, absent distortions and bystanders, transfer induced movements in the terms of trade cannot be large enough (under Walrasian stability) to produce the transfer paradox. Dynamic one-sector models have argued that a transfer paradox is possible, but have relied upon international capital mobility and movements in the world interest rate rather than commodity markets and prices. In a dynamic two-sector overlapping generations model - which allows for both static and intertemporal terms of trade effects -commodity trade can produce a steady state transfer paradox under Walrasian stability, and without distortions or bystanders. The existence of the paradox is due to the effect of the transfer on world capital accumulation which is shown to always (that is, for any ranking of factor intensities and savings rates) improve the donors terms of trade. Transfers may also be Pareto-improving in the steady state, and produce paradoxical welfare results along the transition path.

Capital Mobility in Open OLG Models of Neoclassical Growth

This paper explores whether the international mobility of physical and/or financial capital is essential for productive efficiency in each of three open OLG models of neoclassical growth that vary in terms of dimensional attributes. A tradeoff between capital mobility requirements and dimension has previously been established by example where, ceteris paribus, neither form of capital mobility is required with three productive sectors, only physical capital mobility is required with two sectors, and both forms of mobility are required with a single sector. This paper reconsiders that tradeoff using a generalization of the production and utility functions which introduces the potential for specialization along the transition path--an event which would imply inconsistent capital mobility requirements along the growth path for models with fixed dimension. Conditions are established under which the tradeoff between capital mobility requirements and dimension remains valid. Copyright 2001 by Blackwell Publishing Ltd