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Closing International Real Business Cycle Models with Restricted Financial Markets

Several authors argue that international real business cycle (IRBC) models with incomplete financial markets offer a good explanation of the ranking of cross-country correlations. Unfortunately, this conclusion is suspect, because it is commonly based on an analysis of the near steady state dynamics using a linearized system of equations. The baseline IRBC model with incomplete financial markets does not possess a unique deterministic steady state and, as a result, its linear system of difference equations is not stationary. We show that the explanation of the ranking of cross-country correlations is robust to modifications that ensure a unique steady state and a stationary system of linear difference equations. We find, however, that the modifications affect the quantitative predictions regarding key macroeconomic variables.

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Paper provided by HEC Montréal, Institut d'économie appliquée in its series Cahiers de recherche with number 05-03.

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Length: 40 pages
Date of creation: Mar 2005
Date of revision:
Handle: RePEc:iea:carech:0503
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