Investment and Trade Patterns in a Sticky-Price, Open-Economy Model

Abstract

This paper explores a two-country DSGE model with sticky prices a la Calvo (1983) and local-currency pricing. We analyze the investment decision in the presence of adjustment costs of two types, i.e., capital adjustment costs (CAC) and investment adjustment costs (IAC). We compare the investment and trade patterns with adjustment costs against those of a model without adjustment costs and with (quasi-) flexible prices. We show that having adjustment costs results into more volatile consumption and net exports series, and less volatile investment. We document three important facts on US trade dynamics: (1) the S-shaped cross-correlation between real GDP and the real net exports share, (2) the J-curve between terms of trade and net exports, and (3) the weak and S-shaped cross-correlation between real GDP and terms of trade. We find that adding adjustment costs tends to reduce the model’s ability to match these stylized facts. Nominal rigidities cannot account for these features either.