Trade Flow Dynamics with Heterogeneous Firms

Abstract

We use a two-country, stochastic, general equilibrium model of international trade and macroeconomic dynamics with monopolistic competition and heterogeneous firms to explore the role of entry in the domestic economy and the extensive margin of international trade in the dynamics of U.S. trade flows over the business cycle. We show that the model can reproduce the evidence on the cyclicality of U.S. trade and important features of the evidence on the extensive margins of domestic entry and international trade. Entry in the domestic economy and the implied differences in the timing of export and import expansions in response to favorable productivity shocks provide the key mechanism for the model's ability to explain this range of stylized facts.