DP3259 Trade Openness and Investment Instability

Author(s): Tarek Coury, Assaf Razin, Efraim Sadka
Publication Date: March 2002
Keyword(s): boom-bust investment cycles, lumpy adjustment cost, multiple equilibrium
JEL(s): F10, H10
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3259

In the presence of lumpy adjustment costs of investment, globalization may have non-conventional effects on the level of investment and its cyclical behaviour. Free trade may lead to a discrete ?jump? in the level of investment, as it triggers discrete terms-of-trade changes which either appreciate or depreciate the setup cost of investment. As a result, the economy may alternate between ?optimistic? and ?pessimistic? expectations and self-validating boom and bust investment cycles. There could be substantial gains from globalization in the investment-boom equilibrium and meager, or negative, gains in the investment-bust equilibrium.