Real adjustment of current account imbalances with firm heterogeneity

In this paper, a standard model of international transfer is augmented by the introduction of firm heterogeneity. The increase in aggregate exports in response to the transfer reflects extensive and intensive adjustments, as the sales of new exporting firms (extensive margin) contribute to the current account adjustment along with the sales of existing exporting firms (intensive margin). The relative size of the intensive and extensive margins of the adjustment is determined by the size dispersion of firms. The model calibrated to the observed distribution of firm sizes shows that the intensive margin is the predominant channel of the current account adjustment. The dampening effect of the extensive margin has therefore very little impact on the exchange rate adjustment. © 2011 International Monetary Fund.