Globalization and Macroeconomics.

• Author: Obstfeld, Maurice

Maurice Obstfeld [*]

Although the U.S. economy has become increasingly open over the postwar period, by standard measures the United States remains surprisingly insular. For example, the ratio of U.S international trade to GDP, which stood at only 4.6 percent in 1960, by 1999 was 12.2 percent, nearly three times higher. Still, this is small in absolute terms relative to the trade shares of most smaller economies . [1]

Despite the seeming insularity of the U.S. economy, global considerations have been prominent determinants of American economic policy in recent years. The effect of international trade on the U.S. wage distribution is a key issue in our domestic debates over further trade liberalization and the World Trade Organization. Growing global competition in the financial services industry has progressively undermined the web of financial restrictions that Congress enacted during the Great Depression. Correspondingly, concern for the stability of world capital markets has played a central role in some Federal Reserve actions, including decisions over interest rates.

Since the earliest days of systematic economic analysis, economists have sought to understand how the openness of economies affects their responses to disturbances occurring both at home and abroad. Indeed, the 1999 Nobel Memorial Prize in Economics was presented to Robert A. Mundell in large part for his pioneering studies of the links among economic policy, monetary arrangements, and the degrees of international capital and labor mobility. My recent research concentrates on four sets of questions in international macroeconomics. First, how integrated are world markets, and what does the degree of integration imply for macroeconomic phenomenons? Second, how can we model the open economy in a way that is useful for guiding policy? Third, what are the implications for international monetary arrangements? Fourth, what forces have promoted international economic integration, specifically the integration of capital markets?

Global Economic Integration

Over the past 50 years, technological and political changes have steadily chipped away at the barriers separating nations. As a result, the world is a much smaller place now than it was just after World War II. Labor mobility among nations generally remains low, a fact central to national decisions about exchange rate systems (see below). But along other dimensions, cross-border economic flows have increased dramatically How far short of the ideal of a single, integrated global marketplace for goods, services, and capital is the world's collection of individual national markets now?

In a broad overview of the integration of world capital markets, I document the conflicting messages sent by different measures of international capital mobility. [2] While the markets for some assets appear to be tightly integrated -- for example, the prices of similar nominally risk-free securities are now closely arbitraged without capital-account controls and political risks -- other indicators of capital mobility suggest that significant segmentation remains. For example, investors still display an extreme home bias in their choice of equity holdings. Currently, American investors hold around 12 percent of their equity wealth in foreign stock markets, up sharply from a few years back, but still hard to rationalize within standard models of rational risk-averse agents. Related to the home equity bias is a second puzzle: movements in national per capita consumption appear broadly unrelated to movements in world per capita consumption. This is in contrast to the predictions of benchmark models of efficient international risk sharing. [3]

A third capital-market puzzle, the "Feldstein-Horioka puzzle," is that countries' average saving and investment rates appear closely linked over long periods. Although the magnitude of the saving-investment correlation has declined over time among industrial countries, it remains far higher than the corresponding correlation for subnational regions. Thus, despite the likelihood of independent shifts in national saving behavior and investment opportunities, countries' current account balances, which measure their net accumulations of foreign assets, are surprisingly small. [4]

While attempts to assess the integration of national asset markets have tended to yield conflicting results, attempts to measure the international integration of goods markets yield a much clearer verdict. Despite the trend of postwar trade liberalization and much technological progress, national goods markets appear to remain remarkably isolated from global influences over the medium term. There are big cross-border discrepancies even in the prices of very similar tradable goods, and changes in nominal exchange rates are associated with commensurate and very persistent changes not only in real exchange rates (defined as relative national price levels), but in the relative prices of similar tradable products. However, the feedback of these exchange rate-induced relative price changes into the real economy is extremely slow and difficult to detect in the short run; there often appears to be a high-frequency "disconnect" between exchange rates and the real economy. [5] The measured half-lives for disturbances t o real exchange rates can be as high as four years. Moreover, there is now considerable evidence that producers of differentiated goods "price to market"; that is, they engage in third-degree price discrimination across consumers in different countries and, in particular, fail to offset nominal exchange rate movements through equal price adjustments. [6]

Alan M. Taylor and I, using disaggregated data on consumer prices, estimate a "threshold autoregressive" model in which the costs of international trade discourage arbitrage within a "band of inaction" whose width depends on the magnitude of the costs. We argue that the measured persistence of international price differentials is consistent with a rapid elimination of price discrepancies in excess of trade costs. Standard autoregressive estimates may confound an absence of mean reversion when there are small price discrepancies with more rapid band-reversion in the face of large discrepancies. [7]

A distinct piece of evidence on the segmentation of goods markets comes from studies of the home bias in international trade. Even after controlling for distance, per capita income, and other trade determinants suggested by gravity models of trade, there appears to be an inexplicable and large tendency for regions within countries to trade much more with each other than with residents of foreign countries. [8]

In recent work, Kenneth S. Rogoff and I suggest a reconciliation of the puzzling evidence on the integration of national goods and asset markets. Using simple models, we show that the presence of plausibly sized costs of international trade in goods markets can go remarkably far in explaining a series of international macroeconomic anomalies, in asset markets as well as in...