Dynamic applied general equilibrium trade policy analysis in the presence of foreign asset cross-ownership

Abstract

This paper addresses the question to which extent the prevailing modelling practice of ignoring foreign asset cross-ownership patterns in applied general equilibrium trade policy studies may give rise to distorted predictions. The analytic framework is a stylized dynamic two-country model with international capital mobility and intertemporally optimizing agents. In principle even the sign of the predicted welfare effect of a trade policy shock might reverse, when the actual cross-ownership structure underlying a given net foreign asset position is taken into account. However, the analysis also indicates conditions under which the error incurred by disregarding asset crossholdings remains negligible.