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Robustness, information–processing constraints, and the current account in small open economies

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  • Luo, Yulei
  • Nie, Jun
  • Young, Eric R.

Abstract

In this paper we examine the effects of two types of “induced uncertainty”, model uncertainty due to robustness (RB) and state uncertainty due to finite information–processing capacity (called rational inattention or RI), on consumption and the current account. We show that the combination of RB and RI improves the model's predictions for (i) the contemporaneous correlation between the current account and income and (ii) the volatility and persistence of the current account in small open emerging and developed economies. In addition, we show that the two informational frictions improve the model's ability to match the impulse response of consumption to income and the relative volatility of consumption to income growth.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 88 (2012)
Issue (Month): 1 ()
Pages: 104-120

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Handle: RePEc:eee:inecon:v:88:y:2012:i:1:p:104-120

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Web page: http://www.elsevier.com/locate/inca/505552

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Keywords: Robustness; Rational inattention; Consumption smoothing; Current account; Detection error probabilities;

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Cited by:
  1. Yulei Luo & Jun Nie & Eric R. Young, 2012. "Model uncertainty and intertemporal tax smoothing," Research Working Paper RWP 12-01, Federal Reserve Bank of Kansas City.
  2. Luo, Yulei & Young, Eric, 2013. "Rational Inattention in Macroeconomics: A Survey," MPRA Paper 54267, University Library of Munich, Germany.
  3. Gianluca Benigno & Huigang Chen & Christopher Otrok & Alessandro Rebucci & Eric R. Young, 2011. "Financial Crises and Macro-Prudential Policies," IDB Publications 27738, Inter-American Development Bank.
  4. Luo, Yulei & Young, Eric, 2014. "Induced Uncertainty, Market Price of Risk, and the Dynamics of Consumption and Wealth," MPRA Paper 57111, University Library of Munich, Germany.
  5. Yulei Luo & Jun Nie & Eric R. Young, 2012. "Model uncertainty, state uncertainty, and state-space models," Research Working Paper RWP 12-02, Federal Reserve Bank of Kansas City.
  6. Yulei Luo & Eric R.Young & Jun Nie, 2011. "Robust Control, Informational Frictions, and International Consumption Correlations," 2011 Meeting Papers 209, Society for Economic Dynamics.
  7. Ernesto Pasten, 2012. "Rational Inattention, Multi-Product Firms and the Neutrality of Money," 2012 Meeting Papers 346, Society for Economic Dynamics.

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