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Substitution elasticities and investment dynamics in two country business cycle models

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  • Michael R. Pakko

Abstract

Two country applications of equilibrium business cycle methodology have succeeded in matching some key features of international fluctuations. However, discrepancies between theory and data remain. This paper identifies an anomaly related to a basic property of typical models: The prediction of countercyclical net exports is fundamentally related to a counterfactual implication for negative cross-country investment correlations. The introduction of investment adjustment costs can induce positive investment comovement; however, this has the side-effect of reversing the cyclical behavior of net exports. The calibration of a low elasticity of substitution between domestic goods and imports is shown to be a more robust specification with regard to this and other puzzles that have arisen in the international business cycle literature. ; Earlier title: Substitution elasticities and investment dynamics in international business cycle models

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2002-030.

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Date of creation: 2003
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Publication status: Published in Topics in Macroeconomics, 2003, 3(1), pp. Article 14
Handle: RePEc:fip:fedlwp:2002-030

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Keywords: Business cycles ; International trade ; Balance of trade;

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  1. David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1992. "Dynamics of the trade balance and the terms of trade: the S-curve," Working Paper 9211, Federal Reserve Bank of Cleveland.
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  7. Maurice Obstfeld, 1994. "Are Industrial-Country Consumption Risks Globally Diversified?," NBER Working Papers 4308, National Bureau of Economic Research, Inc.
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  9. Heathcote, Jonathan & Perri, Fabrizio, 2002. "Financial autarky and international business cycles," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 601-627, April.
  10. Michael R. Pakko, 1994. "Characterizing cross-country consumption correlations," Working Papers 1994-026, Federal Reserve Bank of St. Louis.
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Cited by:
  1. Andrea Raffo, 2006. "Net Exports, Consumption Volatility and International Real Business Cycle Models," 2006 Meeting Papers 128, Society for Economic Dynamics.
  2. Wen, Yi, 2007. "By force of demand: Explaining international comovements," Journal of Economic Dynamics and Control, Elsevier, vol. 31(1), pages 1-23, January.
  3. Yi Wen, 2005. "By force of demand: explaining international comovements and the saving-investment correlation puzzle," Working Papers 2005-043, Federal Reserve Bank of St. Louis.
  4. Nuntramas, Phacharaphot, 2011. "Revisiting the consumption-real exchange rate anomaly in a model with non-traded goods," Journal of International Money and Finance, Elsevier, vol. 30(3), pages 428-447, April.

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