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The Valuation Channel of External Adjustment

  • Fabio Ghironi
  • Jaewoo Lee
  • Alessandro Rebucci

    ()

    (Research Department International Monetary Fund)

This paper explores the valuation channel of external adjustment in a two-country dynamic stochastic general equilibrium model (DSGE) with international equity trading. The theoretical model we set up matches key moments of the data for the United States at business cycle frequency at least as well as standard models of international real business cycles (RBCs). In our theoretical analysis, we find that two-asset trading is necessary for a valuation channel of external adjustment to emerge. However, other features of the economy, such as on the nature of the shock that generates the external imbalance and other features of the economy – the extent of nominal rigidity and the size of finacial frictions – determine the magnitude and significance of this channel of adjustment. The relative importance of the valuation channel is larger the higher the degree of nominal rigidity and the higher finacial intermediation costs. Monetary policy shocks have no valuation effects with flexible prices and trade only in equity. Specifying the theoretical model with net foreign assets different from zero in necessary to start matching satisfactorily empirical moments of changes in the US net foreign asset position.

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 195.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:195
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