Adjustment costs and import demand behavior: Evidence from Canada and the United States

In this paper, we examine whether adjustment costs are a significant source of the observed sluggish adjustment of Canadian and US import demand. We use a simple model of a utility maximizing domestic consumer under the assumption of integrated forcing variables to examine the importance of adjustment costs. This formulation of the problem allows us to exploit the recently developed theory of cointegration to estimate the structural parameters of the model using a two-step methodology. Moreover, the formulation incorporates an element of forward-looking behaviour into the decision process; a feature that is important if one assumes adjustment costs are a significant source of persistence in import demand adjustment. The empirical results from a Euler equation imply that adjustment costs in Canada and the United States are important. (JEL C22, F10). (C) 1997 Elsevier Science Ltd.