Trade Wedges, Inventories, and International Business Cycles

The authors show that these trade wedges can reflect the decisions of importers to change their inventory holdings. They find that a two-country model of international business cycles with an inventory management decision can generate trade flows and wedges consistent with the data. Moreover, matching trade flows alters the international transmission of business cycles. Specifically, real net exports become countercyclical and consumption is less correlated across countries than in standard models. The authors also show that ignoring inventories as a source of trade wedges substantially overstates the role of trade wedges in business cycle fluctuations.