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Overoptimism, Boom-Bust Cycles and Monetary Policy in Small Open Economies

In: Monetary Policy under Uncertainty and Learning

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Author Info

  • Manuel Marfán

    (Banco Central de Chile)

  • Juan Pablo Medina

    (Banco Central de Chile)

  • Claudio Soto

    (Banco Central de Chile)

Abstract

This paper analyzes boom-bust cycles in emerging market economies triggered by missperception about future productivity. Using a small open economy DSGE model we show that non-materialized news about future productivity improvements (i.e. overoptimism) generate boom-bust cycles that replicate the stylized facts of several emerging economies during the 1990s. We report simulation results for a boom-bust cycle under alternative monetary policy rules. In this context, we show that if the central bank tries to stabilize output, there would be a large real appreciation of the currency and a deep contraction in the tradable goods sector. When the central bank follows a more strict inflation targeting regime, the boom-bust pattern in major aggregate variables would be exacerbated. Finally, if the central bank attempts to sustain the real exchange rate, the perverse effects on the domestic tradable goods sector are only prevented in the short-run, but the boom-bust cycle in other variables is amplified.

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Bibliographic Info

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This chapter was published in: Klaus Schmidt-Hebbel & Carl E. Walsh & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (Series Editor) (ed.) Monetary Policy under Uncertainty and Learning, , chapter 14, pages 563-600, 2009.

This item is provided by Central Bank of Chile in its series Central Banking, Analysis, and Economic Policies Book Series with number v13c14pp563-600.

Handle: RePEc:chb:bcchsb:v13c14pp563-600

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  1. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Closing Small Open Economy Models," NBER Working Papers 9270, National Bureau of Economic Research, Inc.
  2. Pablo A. Neumeyer & Fabrizio Perri, 2004. "Business cycles in emerging economies: the role of interest rates," Staff Report, Federal Reserve Bank of Minneapolis 335, Federal Reserve Bank of Minneapolis.
  3. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  4. Uribe, Martin & Yue, Vivian Z., 2006. "Country spreads and emerging countries: Who drives whom?," Journal of International Economics, Elsevier, Elsevier, vol. 69(1), pages 6-36, June.
  5. Correia, Maria Isabel Horta & Neves, Joao C & Rebelo, Sérgio, 1994. "Business Cycles in a Small Open Economy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 996, C.E.P.R. Discussion Papers.
  6. Nir Jaimovich & Sergio Rebelo, 2006. "Can News About the Future Drive the Business Cycle?," 2006 Meeting Papers, Society for Economic Dynamics 31, Society for Economic Dynamics.
  7. Nir Jaimovich & Sergio Rebelo, 2008. "News and Business Cycles in Open Economies," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 40(8), pages 1699-1711, December.
  8. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper Series, Federal Reserve Bank of Chicago WP-01-08, Federal Reserve Bank of Chicago.
  9. Beaudry, Paul & Portier, Franck, 2004. "When Can Changes in Expectations Cause Business Cycle Fluctuations in Neo-Classical Settings?," IDEI Working Papers, Institut d'Économie Industrielle (IDEI), Toulouse 304, Institut d'Économie Industrielle (IDEI), Toulouse.
  10. Aguiar, Mark & Gopinath, Gita, 2007. "Emerging Market Business Cycles: The Cycle is the Trend," Scholarly Articles 11988098, Harvard University Department of Economics.
  11. Mark Aguiar & Gita Gopinath, 2004. "Emerging Market Business Cycles: The Cycle is the Trend," NBER Working Papers 10734, National Bureau of Economic Research, Inc.
  12. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999, Society for Computational Economics 1151, Society for Computational Economics.
  13. Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 107(3), pages 797-817, August.
  14. Beaudry, Paul & Portier, Franck, 2001. "An Exploration into Pigou's Theory of Cycles," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2996, C.E.P.R. Discussion Papers.
  15. Gale, D. & Chamley, C., 1992. "Information Revelation and Strategic Delay in a Model of Investment," Papers, Boston University - Department of Economics 10, Boston University - Department of Economics.
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Cited by:
  1. Juan Pablo Medina & Pablo García, 2009. "A Simple Global Perspective on the US Slowdown, Boom-Bust Cycles and the Rise of Protectionism," Working Papers Central Bank of Chile, Central Bank of Chile 529, Central Bank of Chile.

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