Working Paper: NBER ID: w2736
Authors: Jon Cockerline; John F. Helliwell; Robert Lafrance
Abstract: After a survey of alternative theoretical approaches to modeling financial markets, the domestic and international financial linkages of major multicountry models are examined and assessed. The properties of these models are compared by calculating the slopes of their UI and BP curves for the United States, Germany, and Japan. The BP curves (horizontal by assumption in several models) are almost always found to be flatter than the estimated UN curves. International differences in UI slopes are not generally greater than inter-model differences in the estimated slopes of LN curves for any given country. Models with rational or model-consistent expectations in their financial markers tend to show mere appreciation of the U.S. dollar, in response to fiscal expansion, than do models with adaptive expectations, although in both types of model the induced nominal exchange rate changes play a modest role in the transmission linking domestic spending to the current account. Suggestions are made for modeling the increasing globalization of financial markets, and for more explicit treatment of learning behaviour in the modeling of expectations.
Keywords: Financial Markets; Multicountry Models; Fiscal Policy; Exchange Rates
JEL Codes: E44; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Domestic fiscal expansion (E62) | Appreciation of the domestic currency (F31) |
| Steeper LM curve (E12) | Smaller induced capital inflow (F32) |
| Smaller induced capital inflow (F32) | Less expected appreciation from fiscal shocks (H39) |
| Nominal exchange rate changes (F31) | Transmission of domestic spending to the current account (F32) |
| Changes in income and expenditure (H69) | Effects on the current account (F32) |
| Rational expectations models (D84) | Greater appreciation of the US dollar in response to fiscal expansion (F31) |