Aggregate Properties of Open Economy Models with Expanding Varieties.

The article develops a unified framework that establishes an aggregate equivalence between a standard international real business cycle (IRBC) model with production externalities and dynamic international trade models featuring monopolistic competition, heterogeneous firms, and endogenous entry and exit. It demonstrates that standard dynamic trade models imply positive capital externalities, but fitting empirical international business cycle data requires a negative capital externality in the intermediate goods sector. Through quantitative exercises and estimation, the authors show that introducing a negative capital externality improves the model's ability to match key international moments, such as output, investment, labor correlations, and consumption co-movements, under both intermediate and final goods productivity shocks. The findings highlight a puzzle for the literature, suggesting future research should either micro-found a negative capital externality or modify existing models' structures to reconcile positive capital externalities with observed international business cycle patterns.