Dueling Trade Models and the Great Recession

February 02, 2016


The NYT had an article on different trade models that are being used to predict the impact of the Trans-Pacific Partnership (TPP). It reported on the projections from a model from the Peterson Institute which shows that the TPP would add 0.036 percentage points to the annual growth rate over the next 14 years. On the other hand, it reported the projections of a model from Tufts University which showed that deal would lose economy 450,000 jobs (@ 0.3 percent of total employment) and slow growth.

[Dean Baker| February, 2 2016 | Center for Economic and Policy Research]

It would have been helpful to add a bit of background to this dispute. The model from the Peterson Institute explicitly assumes that the trade deal cannot have an effect on the trade deficit and employment:

“The model assumes that the TPP will affect neither total employment nor the national savings (or equivalently trade balances) of countries.”

This was a conventional assumption in trade models prior to the Great Recession. The view was that if a trade deal led to a change in the trade deficit, currencies values would adjust to that the overall trade balance would not change. Furthermore, even if a rise in the trade deficit did lead to some fall in output and employment, this could be offset by fiscal and/or monetary policy. Therefore economists need not worry about trade’s impact on aggregate output and employment.

In the wake of the Great Recession many of the world most prominent economists (e.g. Larry Summers, Paul Krugman, Olivier Blanchard) no longer believe that the economy will automatically bounce back to full employment. They now accept the idea of “secular stagnation,” which means that economies can suffer from long periods of inadequate demand. If secular stagnation is a real problem, then there is no basis for assuming that the demand and jobs lost due to a larger trade deficit can be offset by other policies. 

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