HYSTERESIS IN INTERNATIONAL-TRADE - A GENERAL EQUILIBRIUM-ANALYSIS

This paper presents a simple general equilibrium model of hysteresis in international trade, i.e., temporary exchange rate fluctuations can have persistent effects on trade flows. Besides supporting earlier partial equilibrium results, the analysis bears out a conjecture by Baldwin and Krugman (1989) that a hysteretic shift in trade flows will cause a hysteretic shift in the equilibrium exchange rate. A positive demand shock which leads to a temporary exchange rate appreciation is followed by a persistent depreciation. Another implication is that equity values in the country with a positive demand shock will ultimately fall below their pre-shock level. Temporarily high profits reduce future profitability by attracting competitors who remain in the market after the shock has receded.