Indivisible Labor in a Small Open Economy Model

In this paper, I re-examined standard preferences in a small open economy (SOE) model with indivisible labor calibrated to Canada. It is well known that dynamic small open economy models rely on Greenwood, Hercowitz and Huffman (1988) preferences to match the countercyclical trade balance observed in open economies, as well as other second moments. In contrast, standard preferences a la King, Plosser and Rebelo (1988) are abandoned in this literature and are commonly labeled as ineffective, due to their inability to yield a countercyclical trade balance. Contrary to prior claims, this paper shows that a SOE model with standard preferences and indivisible labor obtains a countercyclical trade balance and well matches main empirical regularities that emerge in open economies.