Endogenous trade participation with price rigidities

Abstract

This paper investigates the interaction of endogenous export participation and nominal rigidities and its implications for the dynamics of intensive and extensive margins of trade. I develop a two-country dynamic stochastic general equilibrium model wherein firms make state-dependent decisions on entry and exit in the export market, and where price adjustments are staggered across firms and time.My model reveals that, when an aggregate shock has significant effects on optimal export prices, such as a shock to domestic productivity or monetary policy, it generates large responses in the number of exporters. These movements in turn amplify responses along the intensive margin of trade and international transmission of the shock. I trace this result to the micro-level price rigidities in my model. Because staggered price changes delay intensive margin adjustments among incumbent exporters following aggregate shocks, they permit sizable shifts in the profitability of export participation. Whereas such shifts are virtually eliminated in models of exporter entry and exit with flexible prices, here they are sufficient to induce quantitatively important movements along the extensive margin of trade.