Working Paper: NBER ID: w26426
Authors: Oliver de Groot; Ceyhun Bora Durdu; Enrique G. Mendoza
Abstract: Global and local methods widely used to study open-economy incomplete-markets models yield very 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 inaccuracies in the autocorrelation of Net Foreign Assets resulting from assumptions used to induce stationarity cause the local solutions’ flaws. DynareOBC solutions of a Sudden Stops model with an occasionally binding collateral constraint yield similar flaws and sharply underestimate the effects of the constraint on financial premia and macroeconomic variables. Local methods yield much larger Euler equation errors and are of comparable speed for the Sudden Stops model.
Keywords: open-economy models; incomplete markets; precautionary savings; financial frictions
JEL Codes: E44; E47; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| local methods yield significantly larger Euler equation errors (C20) | accuracy of predicted economic dynamics (E17) |
| assumptions used to induce stationarity (C22) | inaccuracies in the autocorrelation of NFA (C22) |
| inaccuracies in the autocorrelation of NFA (C22) | discrepancies in the long-run moments and impulse response functions of key economic variables (E19) |
| local methods overestimate the variability of consumption and net exports (NX) (E20) | underestimate the correlations of these variables with income (C29) |
| global solutions predict larger increases in mean NFA (E17) | higher variability of shocks (D89) |
| local methods maintain certainty equivalence (C62) | fundamentally different economic implications (F69) |