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Can a small New Keynesian model of the world economy with risk‐pooling match the facts?

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  • Patrick Minford
  • Zhirong Ou
  • Zheyi Zhu

Abstract

We ask whether a model of the US and Europe trading with the rest of the world can match the facts of world behaviour in a powerful indirect inference test. One version has uncovered interest parity (UIP), the other risk‐pooling. Both pass the test but the most probable is risk‐pooling. This is consistent with risk‐pooling failing a number of single‐equation tests, as has been found in past work; we show that these tests will typically reject risk‐pooling when it in fact prevails. World economic behaviour under risk‐pooling shows much stronger spillovers than under UIP with opposite monetary responses to the exchange rate. We argue that the risk‐pooling model therefore demands more attention from policy‐makers.

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  • Patrick Minford & Zhirong Ou & Zheyi Zhu, 2021. "Can a small New Keynesian model of the world economy with risk‐pooling match the facts?," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(2), pages 1993-2021, April.
    • Handle: RePEc:wly:ijfiec:v:26:y:2021:i:2:p:1993-2021
    DOI: 10.1002/ijfe.1890
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    1. Minford, Patrick & Ou, Zhirong & Wickens, Michael & Zhu, Zheyi, 2022. "The eurozone: What is to be done to maintain macro and financial stability?," Journal of Financial Stability, Elsevier, vol. 63(C).

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    More about this item

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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