Business cycle accounting of trade barriers in a small open economy

Abstract

To what extent can a short-term decline in the output of a small open economy be explained by trade barriers? To answer this, we extend the Business Cycle Accounting method of Chari et al. (2007) to a small open economy model. We include an additional time-varying wedge to model financial trade frictions caused by barriers on imports. International sanctions on Iran provide an empirical opportunity to apply this method to data on Iran’s recession in 2012-13. The results indicate that efficiency and investment wedges account for most of the fluctuations in aggregate variables during the sanctions, and trade barriers had little contemporaneous explanatory power. The effect of oil boycotts remains unknown.