Scandinavian Working Papers in Economics

Working Paper Series,
Sveriges Riksbank (Central Bank of Sweden)

No 186: Trade Deficits in the Baltic States: How Long Will the Party Last?

Rudolfs Bems () and Kristian Jönsson ()
Additional contact information
Rudolfs Bems: Stockholm School of Economics, Postal: Department of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden
Kristian Jönsson: Research Department, Central Bank of Sweden, Postal: Sveriges Riksbank, SE-103 37 Stockholm, Sweden

Abstract: Since their opening up to international capital markets, the economies of Estonia, Latvia and Lithuania have experienced large and persistent capital inflows and trade deficits. This paper investigates whether a calibrated two-sector neoclassical growth model can explain the magnitudes and the timing of the trade flows in the Baltic countries. The model is calibrated for each of the three countries, which we simulate as small closed economies that suddenly open up to international trade and capital flows. The results show that the model can account for the observed magnitudes of the trade deficits in the 1995-2001 period. Introducing a real interest rate risk premium in the model increases its explanatory power. The model indicates that trade balances will turn positive in the Baltic states around 2010.

Keywords: Baltic states; international factor movements; non-traded goods; adjustment costs; dynamic general equilibrium

JEL-codes: C68; F41

43 pages, June 1, 2005

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