Macroeconomic Volatility and Trade in OLG Economies

This chapter analyzes the effect of international trade on the local stability properties of economies in a Heckscher-Ohlin free-trade equilibrium. We formulate a two-factor (capital and labor), two-good (consumption and investment), two-country overlapping generations model where countries only differ with respect to their discount rate. We consider a CES non increasing returns to scale technology in the consumption good sector and a Leontief constant returns to scale technology in the investment good sector. In the autarky equilibrium and the free-trade equilibrium, we show the existence of endogenous cycles with dynamic efficiency when the consumption good is capital intensive, the value of the elasticity of intertemporal substitution in consumption is intermediate and the degree of returns to scale is sufficiently high. Finally using a numerical simulation, we show that period-two cycles can occur in the free-trade equilibrium although one country is characterized by saddle-point stability in the autarky equilibrium.