How Trade Restrictions Disperse: Policy Dynamics with Firm Selection

Abstract

In this paper, I explore the aggregate effects of trade restrictions in a two-country, dynamic, stochastic, general equilibrium (DSGE) model with firm selection and variable adjustment of markup. As a response to the trade collapse in the global crisis of 2008 and 2009, trade restrictions have emerged in several countries. With analyzing the dynamics of an economic slump in the home economy first, and the subsequent introduction of trade restrictions in the foreign economy second, I show that both economies are in a worse position than they were during the economic downturn. The follow-ups to the recession and trade restrictions are investigated through three mechanisms: a) variable markup as a new avenue of increasing competitive pressure for producers (e.g. more competitive firms lower their markups.); b) average individual firms' specific productivity cut-off, which induces their optimum export choice (e.g. an increase in the export productivity cut-off means exporting becomes more difficult than before.); and c) the movement of international relative prices (e.g. the real exchange rate and terms of trade).