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Closing Small Open Economy Models

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  • Stephanie Schmitt-Grohe
  • Martin Uribe

Abstract

The small open economy model with incomplete asset markets features a steady state that depends on initial conditions and equilibrium dynamics that possess a random walk component. A number of modifications to the standard model have been proposed to induce stationarity. This paper presents a quantitative comparison of these alternative approaches. Five different specifications are considered: (1) A model with an endogenous discount factor (Uzawa-type preferences); (2) A model with a debt-elastic interest-rate premium; (3) A model with convex portfolio adjustment costs; (4) A model with complete asset markets; and (5) A model without stationarity-inducing features. The main finding of the paper is that all models deliver virtually identical dynamics at business-cycle frequencies, as measured by unconditional second moments and impulse response functions. The only noticeable difference among the alternative specifications is that the complete-asset-market model induces smoother consumption dynamics.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9270.

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Date of creation: Oct 2002
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Publication status: published as Schmitt-Grohe, Stephanie & Uribe, Martin, 2003. "Closing small open economy models," Journal of International Economics, Elsevier, vol. 61(1), pages 163-185, October.
Handle: RePEc:nbr:nberwo:9270

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  1. Pablo Andres Neumeyer & Fabrizio Perri, 1999. "Business Cycles in Emerging Economies: the role of interest rates," Department of Economics Working Papers, Universidad Torcuato Di Tella 014, Universidad Torcuato Di Tella.
  2. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Stabilization policy and the costs of dollarization," Proceedings, Federal Reserve Bank of Cleveland, Federal Reserve Bank of Cleveland, pages 482-517.
  3. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers, National Bureau of Economic Research, Inc 1389, National Bureau of Economic Research, Inc.
  4. Baxter, M. & Crucini, M., 1991. "Business Cycles and the Asset Structure of Foreign Trade," RCER Working Papers, University of Rochester - Center for Economic Research (RCER) 316, University of Rochester - Center for Economic Research (RCER).
  5. Stephanie Schmitt-Grohe, 1995. "The international transmission of economic fluctuations: effects of U. S. business cycles on the Canadian economy," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 95-6, Board of Governors of the Federal Reserve System (U.S.).
  6. Obstfeld, Maurice, 1990. "Intertemporal dependence, impatience, and dynamics," Journal of Monetary Economics, Elsevier, Elsevier, vol. 26(1), pages 45-75, August.
  7. Robert Kollmann, 1996. "Incomplete asset markets and the cross-country consumption correlation puzzle," ULB Institutional Repository, ULB -- Universite Libre de Bruxelles 2013/7640, ULB -- Universite Libre de Bruxelles.
  8. Correia, Isabel & Neves, Joao C. & Rebelo, Sergio, 1995. "Business cycles in a small open economy," European Economic Review, Elsevier, Elsevier, vol. 39(6), pages 1089-1113, June.
  9. Martin Uribe, 1995. "Exchange-rate based inflation stabilization: the initial real effects of credible plans," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 503, Board of Governors of the Federal Reserve System (U.S.).
  10. Kim, Sunghyun Henry & Kose, M. Ayhan, 2003. "Dynamics Of Open-Economy Business-Cycle Models: Role Of The Discount Factor," Macroeconomic Dynamics, Cambridge University Press, Cambridge University Press, vol. 7(02), pages 263-290, April.
  11. Ghironi, Fabio, 2006. "Macroeconomic interdependence under incomplete markets," Journal of International Economics, Elsevier, Elsevier, vol. 70(2), pages 428-450, December.
  12. Mendoza, Enrique G. & Uribe, Martin, 2000. "Devaluation risk and the business-cycle implications of exchange-rate management," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 53(1), pages 239-296, December.
  13. Cardia, Emanuela, 1991. "The dynamics of a small open economy in response to monetary, fiscal, and productivity shocks," Journal of Monetary Economics, Elsevier, Elsevier, vol. 28(3), pages 411-434, December.
  14. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, American Economic Association, vol. 81(4), pages 797-818, September.
  15. repec:fth:harver:1504 is not listed on IDEAS
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