Working Paper: CEPR ID: DP3096
Authors: Stephanie Schmitt-Grohe; MartÃn Uribe
Abstract: The small open economy model with incomplete asset markets features a steady state that depends on initial conditions. In addition, equilibrium dynamics posses a random walk component. A number of modifications to the standard model have been proposed to induce stationarity. This Paper presents a quantitative comparison of these alternative approaches. Five different specifications are considered: (1) A model with an endogenous discount factor (Uzawa-type preferences); (2) A model with a debt-elastic interest-rate premium; (3) A model with convex portfolio adjustment costs; (4) A model with complete asset markets; (5) A model without stationarity-inducing features. The main finding of the Paper is that all models deliver virtually identical dynamics at business-cycle frequencies, as measured by unconditional second moments and impulse response functions. The only noticeable difference among the alternative specifications is that the complete-asset-market model induces smoother consumption dynamics.
Keywords: Complete and incomplete asset markets; Small open economy; Stationarity
JEL Codes: F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Modifications to the small open economy model aimed at inducing stationarity (E19) | Consumption dynamics (E21) |
| Modifications to the small open economy model aimed at inducing stationarity (E19) | Output dynamics (C69) |
| Modifications to the small open economy model aimed at inducing stationarity (E19) | Investment dynamics (G11) |
| Modifications to the small open economy model aimed at inducing stationarity (E19) | Hours worked dynamics (J29) |
| Modifications to the small open economy model aimed at inducing stationarity (E19) | Trade balance dynamics (F14) |
| Complete asset market model induces smoother consumption dynamics (D15) | Consumption dynamics (E21) |