The non-technical abstract of the grant proposal states "Our proposed research aims to bridge a gap between modern models of international macroeconomics and trade. International macroeconomic models do not typically study the entry and exit decisions of firms, and their decisions to serve export markets. We introduce all these firm-level features into such a model. Firms in each country must make an irreversible investment when entering their domestic market; they then produce with different productivity levels. Firms also face both per-unit and fixed (independent of export volume) trade costs. Only a subset of relatively more productive firms export, while the other less productive firms only serve their domestic market. We then study how macroeconomic shocks affect the pattern of firm entry across countries, and the firms' export decision. Improvements in a country's business environment induce higher rates of firm entry. Similarly, when export conditions improve, more firms start exporting; conversely, some firms exit the export market when those conditions deteriorate. These firm-level decisions alter the range of goods available for consumption in both countries. Our model captures the aggregate implications of this firm-level structure, as well as the feedback loop from the induced changes in the macroeconomic environment back to the firm-level decisions.

Incorporating these firm-level decisions provides some very important insights into the behavior of key macroeconomic variables. Our model explains why more productive countries (or less regulated economies) exhibit higher relative prices than their trading partners (through the impact of entry on labor costs). It also explains why productivity improvements can be associated with improvements in a country's terms of trade. These explanations critically rely on the new firm-level structure we have introduced (which implies that firms will predominantly choose to enter the market that provides the more attractive business environment). The firm-level dynamics also imply that the responses to macroeconomic shocks are very persistent, much more so than the shocks themselves. This provides some new explanations for the high persistence levels that are commonly observed in empirical work.

Our study also highlights some potential problems with the measurement of international relative prices. These relative prices are used to adjust important international statistics such as income per capita. However, the methods used may not properly account for the effect of firm entry and product variety, leading to biased cross-country comparisons. The policy implications of this issue are apparent, as these comparisons are used to make decisions such as the allocation of international aid. We will explore this question in future theoretical and empirical work. In addition, we will extend our model to incorporate nominal rigidity and a role for monetary policy. This extension will improve the empirical performance of our model. It will allow us to study how changes in monetary policy regime affect the economy (and consumer welfare) by altering firm entry and exit decisions."