We assess the ability of new open economy models to match OECD business cycle data. We adopt a canonical new open economy model with varying degrees of nominal inertia, monopolistic competition and distribution costs and assess the contribution of each facet of this model to help explain jointly the volatility and persistence of real exchange rates and the dynamics of the current account. Building on Chari, Kehoe and McGrattan (2002) and Schmitt-Grohe and Uribe (2003), we find that standard models do not capture these important relative price and quantity dynamics at the business cycle frequency. We explore the extent to which three extensions to the existing literature further our understanding: (i) overlapping generations, (ii) sunspots and (iii) financial frictions.
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Find related papers by JEL classification: E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics