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Why Global and Local Solutions of Open-Economy Models with Incomplete Markets Differ and Why it Matters

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  • Oliver de Groot
  • Ceyhun Bora Durdu
  • Enrique G. Mendoza

Abstract

Global and local methods used to study open-economy incomplete-markets models yield different cyclical moments, impulse responses, spectral densities and precautionary savings. Endowment and RBC model solutions obtained with first-order, higher-order, and risky-steady-state local methods are compared with fixed-point-iteration global solutions. Analytic and numerical results show that the differences are due to the near-unit-root nature of net foreign assets under incomplete markets and inaccuracies of local methods in computing their autocorrelation. In a Sudden Stops model, quasi-linear methods that handle occasionally binding constraints understate the size of credit constraint multipliers, financial premia and macroeconomic responses.

Suggested Citation

  • Oliver de Groot & Ceyhun Bora Durdu & Enrique G. Mendoza, 2023. "Why Global and Local Solutions of Open-Economy Models with Incomplete Markets Differ and Why it Matters," NBER Working Papers 31544, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:31544
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    More about this item

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles
    • G01 - Financial Economics - - General - - - Financial Crises
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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