Federal Reserve Bank of Dallas Globalization and Monetary Policy Institute Product Durability and Trade Volatility Jel Codes: F11

One of the main causes behind the trade collapse of 2008-09 was a significant fall in the demand for durable goods. This paper develops a small country, overlapping generations model of international trade in which goods durability gives rise to a more than proportional fall in trade volumes, as observed in 2008-09. The model has three goods-two durable, traded goods and one non-durable, non-traded good and two factors of production. The durability of goods affects consumers' lifetime wealth and their optimal consumption bundle across goods and time periods. A uniform productivity shock reduces consumers' lifetime wealth inducing a re-optimisation away from durables. This gives rise to a more than proportional effect on international trade, provided the non-traded sector is sufficiently capital intensive. The elasticity of trade flows to GDP is found to be increasing in both the degree of durability and the size of the shock. Thus the model provides microfoundations for the asymmetric shock to the demand for durable goods observed in recessions and clarifies the link between this endogenous shift in preferences and international trade flows. It also explains the observation that deeper downturns are associated with a higher elasticity of trade to GDP. Furthermore, the greater the degree of durability of traded goods, the larger is the share of domestically produced goods in consumption, for plausible factor intensities. This provides an alternative explanation for the home bias in consumption, and hence another explanation for Trefler's "missing trade." to participants of the 2011 ETSG conference and seminar participants at the University of Oxford and the University of Sussex for useful comments and suggestions. Particular thanks go to Alan Winters, Peter Neary and Tony Venables. The authors are responsible for any errors and omissions. The views in this paper are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of Dallas or the Federal Reserve System.