Advanced Search
MyIDEAS: Login

Spurious Welfare Reversals in International Business Cycle Models

Contents:

Author Info

  • Jinill Kim

    ()

  • Sunghyun Henry Kim

    ()

Abstract

Several papers on international business cycles have documented spurious welfare reversals, in that incomplete market economies can produce higher welfare than the complete market economy. This paper demonstrates how conventional linearization, as used in King, Plosser, and Rebelo (1988), can generate approximation errors that are large enough to result in such reversals. Using a two-country production economy without capital, we argue that spurious welfare reversals are not only possible but also plausible under reasonable parameter values. As a constructive alternative, this paper proposes an approximation method that modifies the conventional linearization method by a bias correction---the linear approximation around a 'stochastic' steady state. We show that this method can be easily implemented to accurately approximate the exact solution and therefore produce the correct welfare ordering. The accuracy of the proposed method is far better than that of the conventional linearization method and as good as that of a method involving a second-order expansion.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.virginia.edu/economics/RePEc/vir/virpap/papers/virpap319.pdf
Download Restriction: no

Bibliographic Info

Paper provided by University of Virginia, Department of Economics in its series Virginia Economics Online Papers with number 319.

as in new window
Length: 42 pages
Date of creation: Oct 1999
Date of revision:
Handle: RePEc:vir:virpap:319

Contact details of provider:
Web page: http://www.virginia.edu/economics/home.html

Related research

Keywords: Linearization; Stochastic steady state; Welfare; Risk sharing;

Other versions of this item:

Find related papers by JEL classification:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Jinill Kim & Sunghyun Henry Kim & Andrew Levin, 2001. "Patience, persistence and welfare costs of incomplete markets in open economies," International Finance Discussion Papers 696, Board of Governors of the Federal Reserve System (U.S.).
  2. Jess Gaspar & Kenneth L. Judd, 1997. "Solving Large Scale Rational Expectations Models," NBER Technical Working Papers 0207, National Bureau of Economic Research, Inc.
  3. Woodford Michael, 2002. "Inflation Stabilization and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, vol. 2(1), pages 1-53, February.
  4. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
  5. Cole, Harold L. & Obstfeld, Maurice, 1991. "Commodity trade and international risk sharing : How much do financial markets matter?," Journal of Monetary Economics, Elsevier, vol. 28(1), pages 3-24, August.
  6. van Wincoop, Eric, 1999. "How big are potential welfare gains from international risksharing?," Journal of International Economics, Elsevier, vol. 47(1), pages 109-135, February.
  7. Maurice Obstfeld & Kenneth Rogoff, 1998. "Risk and Exchange Rates," NBER Working Papers 6694, National Bureau of Economic Research, Inc.
  8. Collard, Fabrice & Juillard, Michel, 1999. "Accuracy of stochastic perturbuation methods: the case of asset pricing models," CEPREMAP Working Papers (Couverture Orange) 9922, CEPREMAP.
  9. repec:cup:macdyn:v:1:y:1997:i:1:p:45-75 is not listed on IDEAS
  10. Tesar, Linda L., 1995. "Evaluating the gains from international risksharing," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 42(1), pages 95-143, June.
  11. Jang-Ok Cho & Thomas Cooley & Louis Phaneuf, 1994. "The Welfare Costs of Nominal Wage Contracting," Cahiers de recherche CREFE / CREFE Working Papers 30, CREFE, Université du Québec à Montréal, revised 22 Jan 1996.
  12. Benigno, Gianluca & Benigno, Pierpaolo, 2001. "Monetary Policy Rules and the Exchange Rate," CEPR Discussion Papers 2807, C.E.P.R. Discussion Papers.
  13. Chris Otrok, 1999. "On Measuring the Welfare Cost of Business Cycles," Virginia Economics Online Papers 318, University of Virginia, Department of Economics.
  14. Viceira, Luis & Campbell, John, 2001. "Who Should Buy Long-Term Bonds?," Scholarly Articles 3128709, Harvard University Department of Economics.
  15. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1992. "International Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 100(4), pages 745-75, August.
  16. Dale W. Henderson & Jinill Kim, 1999. "Exact utilities under alternative monetary rules in a simple macro model with optimizing agents," International Finance Discussion Papers 635, Board of Governors of the Federal Reserve System (U.S.).
  17. Henning Bohn, 1999. "Online Appendix to Should the Social Security Trust Fund hold Equities? An Intergenerational Welfare Analysis," Technical Appendices bohn99, Review of Economic Dynamics.
  18. Jinill Kim & Dale Henderson, 2002. "Inflation Targeting and Nominal Income Growth Targeting: When and Why Are They Suboptimal?," Computing in Economics and Finance 2002 59, Society for Computational Economics.
  19. Wouter J. den Haan & Albert Marcet, 1993. "Accuracy in simulations," Economics Working Papers 42, Department of Economics and Business, Universitat Pompeu Fabra.
  20. Devereux, Michael B. & Saito, Makoto, 1997. "Growth and risk-sharing with incomplete international assets markets," Journal of International Economics, Elsevier, vol. 42(3-4), pages 453-481, May.
  21. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  22. repec:fth:calaec:4-98 is not listed on IDEAS
  23. Ellen R. McGrattan, 1991. "The macroeconomic effects of distortionary taxation," Discussion Paper / Institute for Empirical Macroeconomics 37, Federal Reserve Bank of Minneapolis.
  24. Lewis, Karen K., 2000. "Why do stocks and consumption imply such different gains from international risk sharing?," Journal of International Economics, Elsevier, vol. 52(1), pages 1-35, October.
  25. Taylor, John B & Uhlig, Harald, 1990. "Solving Nonlinear Stochastic Growth Models: A Comparison of Alternative Solution Methods," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 1-17, January.
  26. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : II. New directions," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 309-341.
  27. Mark Bils & Yongsung Chang, 1999. "Wages and the Allocation of Hours and Effort," NBER Working Papers 7309, National Bureau of Economic Research, Inc.
  28. Ireland, Peter N., 1997. "A small, structural, quarterly model for monetary policy evaluation," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 47(1), pages 83-108, December.
  29. Julio Rotemberg & Michael Woodford, 1997. "An Optimization-Based Econometric Framework for the Evaluation of Monetary Policy," NBER Chapters, in: NBER Macroeconomics Annual 1997, Volume 12, pages 297-361 National Bureau of Economic Research, Inc.
  30. Mendoza, Enrique G, 1995. "The Terms of Trade, the Real Exchange Rate, and Economic Fluctuations," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(1), pages 101-37, February.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
This item has more than 25 citations. To prevent cluttering this page, these citations are listed on a separate page.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:vir:virpap:319. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Debby Stanford).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.