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Financial integration, credit market imperfections and consumption smoothing
Abstract
Contrary to standard theoretical reasoning, recent empirical research shows that financial integration is associated with higher consumption volatility in developing countries. This paper illustrates how domestic credit market imperfections can alter the standard predictions about the consumption smoothing possibilities under financial autarky and international financial integration. I use a two-country international real business cycle model where the non-traded sector in the small country faces borrowing constraints due to contract enforceability problems. If the international risk-sharing opportunities are non-existent, households can secure themselves against the shocks in the non-traded sector only by adjusting their labor effort, which leads to changes in sectorial output and terms of trade. The deterioration of the terms of trade acts as a dampening effect on consumption, causing it to be less volatile under financial autarky relative to financial integration. Under financial integration, international financial assets provide the insurance against domestic productivity shocks without affecting the relative prices, hence allowing the consumption to react more.
... Earlier work mainly analyses the effect of domestic financial system development on output and consumption volatility through its effect on firms (Aghion et al. 2004(Aghion et al. , 2010. Some papers focus on the impact of financial globalisation on volatility (Aghion et al. 2004;Buch et al. 2005;Leblebicioglu 2009). The effect of domestic financial system development on output and consumption volatility is explored in a limited strand of literature. ...
... Source: Authors' analysis outlined in the Consumption Volatility and Permanent versus Transitory Income Shocks section. Buch et al. 2005;Leblebicioglu 2009;Aghion et al. 2010). The effect of financial integration on macroeconomic volatility dominates the literature. ...
... Earlier work mainly analyses the effect of domestic financial system development on output and consumption volatility through its effect on firms (Aghion et al. 2004(Aghion et al. , 2010. Some papers focus on the impact of financial globalisation on volatility (Aghion et al. 2004;Buch et al. 2005;Leblebicioglu 2009). The effect of domestic financial system development on output and consumption volatility is explored in a limited strand of literature. ...
... Source: Authors' analysis outlined in the Consumption Volatility and Permanent versus Transitory Income Shocks section. Buch et al. 2005;Leblebicioglu 2009;Aghion et al. 2010). The effect of financial integration on macroeconomic volatility dominates the literature. ...
... Because of this mechanism, they show that when the asset market is incomplete due to sovereign risk, financial globalization can lead to losses of risk sharing opportunities both within and between countries, and hence to losses in welfare. Leblebicioglu (2008) Under autarchy however, the only way workers can increase their revenue is to work more for the T sector. This worsens the terms of trade and hence renders the home consumption bundle more expensive which then dampens the increase in consumption. ...
... Our findings are consistent with some general equilibrium models with frictions both in the domestic and in the international financial markets (Leblebicioglu (2008)). These results support the idea that when the domestic financial system is weak, exposition to international capital flows might exacerbate existing distortions due to capital market imperfections, and hence amplify economic fluctuations. ...
Individuals living in developing economies are subject to a wide variety of risks. Moreover, since private and public formal institutions designed to help individuals coping with risks tend to be weaker and narrower than in rich countries, these risks very often bear a heavy burden on welfare. If the preferences of agents can be characterized by concave utility functions, these agents will want to spread risk across time and among themselves. We focus here on mechanisms allowing agents to share risk among themselves, and we look more particularly at environments where formal insurance options are incomplete or absent. This thesis offers three chapters which goal is to analyze the extent to which risk sharing is affected by imperfections in the insurance or in the credit markets. In the first two chapters, we take a microeconomic perspective and we examine how rural farmers cope with income shocks in village economies characterized by the absence of formal insurance markets. In the last chapter, we adopt a macroeconomic perspective and we look at the role of the domestic financial sector development in fostering risk sharing through financial integration between countries.
... Because of this mechanism, they show that when the asset market is incomplete due to sovereign risk, financial globalization can lead to losses of risk sharing opportunities both within and between countries, and hence to loss in welfare. Leblebicioglu (2005) analyzes formally the interaction effects between domestic credit market imperfection and financial integration. She develops a two-country two-sector real business cycle model where one of the countries faces asymmetric credit conditions in the sense that traded good (T) firms have access to international finance while non traded good (NT) firms are restricted to the imperfect domestic capital market. ...
... Our findings are consistent with general equilibrium models including frictions both in the domestic and in the international financial markets Leblebicioglu (2005). These results support the idea that when the domestic financial system is weak, exposition to international capital flows might exacerbate existing distortions due to capital market imperfections, and hence amplify economic ...
In this paper, we analyze the relationship between international financial integration and macroeconomic volatility. Looking at a panel of 90 countries over the period 1960-2000, we find that domestic financial conditions matter when assessing the impact of financial integration on consumption growth volatility. More specifically, consumption growth volatility is found to increase with the degree of financial integration in countries with low level of financial development and to decrease in countries with high level of financial development. When measuring domestic financial conditions by the share of private credits to GDP, the threshold level of financial development above which financial integration yields consumption smoothing benefits is estimated to be around 60%-70% GDP.
... This distinction is important as studies on the nexus between financial liberalisation and macroeconomic outcomes can arrive at systematically different findings depending on the choice of using either de facto or de jure measures (Bataka, 2019;Gygli et al., 2019;Quinn et al., 2011). We use the recently proposed revised KOF Globalisation Index 1 Related theoretical works of Leblebicioğlu (2009) and Levchenko (2005) show that financial integration increases consumption volatility in developing countries due to local market imperfections. Agents with access to international financial markets stop participating in local risk-sharing arrangements with those without such access. ...
Using data from 109 countries from 1980 to 2018, we examine the nonlinear relationship between financial globalisation and poverty. Financial globalisation is further segregated into de facto and de jure dimensions to study their differential impact on poverty. We have two main findings with important implications. First, our results point to significant nonlinearities, indicating that the relationship between financial globalisation and poverty is non‐monotonic. There exists a threshold above which the marginal effect of financial globalisation on poverty is negative. Moreover, the effect of financial globalisation on poverty is stronger for countries with high institutional characteristics. Second, we also show that the effect of financial globalisation is non‐monotonic and heterogeneous across different quantiles of poverty distribution. The effect of financial globalisation is relatively stronger at the higher quantile of poverty distribution for the overall sample. However, we find the existence of a U‐shaped and an inverted U‐shaped relationship between financial globalisation and poverty across quantiles, conditional on a country's economic development and institutional quality. The results are robust to alternative measures of poverty and financial globalisation. We account for unobserved heterogeneity and use multiple econometric approaches to validate our results.
... The lack of well-developed financial markets also appears to be a key reason explaining the positive association between financial integration and the relative volatility of consumption growth documented by Kose, Prasad and Terrones (2003b). For instance, Levchenko (2005) and Leblebicioglu (2006) consider dynamic general equilibrium models where only some agents have access to international financial markets. In both models, capital account liberalization leads to an increase in the volatility of aggregate consumption since agents with access to international financial markets stop participating in risk-sharing arrangements with those who do not have such access. ...
The paper examines the impact of financial integration on economic growth in sub-Saharan Africa (SSA). Using a dynamic panel Generalised Method of Moment (GMM), the paper finds that financial integration had a negative and significant impact on economic growth in SSA. The results also reveal that institutional quality had a negative and significant impact on economic growth in SSA. The results of the paper further show that financial development had negative impact on economic growth in the region. The paper concludes that the economies did not reap the benefits of financial integration. The government in the region needs to put in place appropriate macroeconomic policies and institutions that will drive the benefits of financial integration in order to sustain economic development.
... . 32 In the environment of multiple distortions of our model, it is not automatic that increasing financial market integration should always be welfare-improving. See Auray and Eyquem (2014) and Leblebicioğlu (2009) for other examples of situations where financial integration can lower welfare in second-best environments. 33 For instance, Chung, Jung, and Yang (2007), Eichengreen (2004b), Milani and Park (2015), Ortiz, Ottonello, Sturzenegger, and Talvi (2009), and Ortiz and Sturzenegger (2007). ...
We study the consequences of different degrees of international financial market integration and exchange rate policies in a calibrated, medium-scale model of the Korean economy. The model features endogenous producer entry into domestic and export markets and search-and-matching frictions in labor markets. This allows us to highlight the consequences of financial integration and the exchange rate regime for the dynamics of business creation and unemployment. We show that, under flexible exchange rates, access to international financial markets increases the volatility of both business creation and the number of exporting plants, but the effects on employment volatility are more modest. Pegging the exchange rate can have unfavorable consequences for the effects of terms of trade appreciation, but more financial integration is beneficial under a peg if the economy is subject to both productivity and terms of trade shocks. The combination of a floating exchange rate and internationally complete markets would be the best scenario for Korea among those we focus on.
... Financial integration and improved access to financial markets of particularly poorer households are generally found to improve consumption insurance and thus should lead to less inequality in consumption (Hulme and Mosley, 1996;Japelli and Pistaferri, 2011). Financial markets in Korea show themselves much more inclusive and liberalized today than compared with 20 or 30 years ago (Park, 1994;Ang, 2010). ...
Using 30 years of the South Korean household income and expenditure surveys (HIES) from 1982 to 2011, this paper argues that Korea experienced significantly differing generational trends in consumption and income inequality when taking demographic changes related to population aging into account. While income inequality stagnated or slightly rose over the past two generations, consumption inequality in fact declined. These antagonistic trends are likely due to better access of poorer households to financial markets as well as the gradual expansion of the welfare state. In the absence of appropriate policies, rapid population aging will substantially increase overall inequality in the future.
... We therefore argue that international eorts to restrict trade-based instruments would make vulnerable populations at risk without necessarily mitigating food price volatility. More broadly, our paper relates to the literature on the interplay between domestic and international risk-sharing in the presence of domestic asset market frictions (Levchenko, 2005;Leblebicioglu, 2009;Broner and Ventura, 2011). A repeated nding in this literature is that an increase in international risk-sharing can lead domestic risksharing to break down. ...
In a world with volatile food prices, countries have an incentive to shelter their popu-lations from the induced real income shocks. When some agents are net food producers while others are net consumers, there is scope for insurance between the two groups. A domestic social protection scheme would therefore transfer resources away from the former group to the latter in times of high food prices, and do the reverse otherwise. We show that in the presence of consumer preference heterogeneity, implementing the optimal social protection policy can potentially induce higher food price volatility. Such policy indeed generates a counter-cyclical demand shock that amplies the eects of the underlying food shortage. Our results call for a reassessment of food stabilization policies. In particular, we urge caution against the systematic condemnation of trade insulation practices. participants at the 2012 NBER conference on the Economics of Food Price Volatility for very helpful discussions. The ndings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily reect the views of the World Bank, its Executive Directors, or the countries they represent. World Bank, University of Michigan and NBER, and World Bank, respectively.
... Alternatively, Kollintzas and Vassilatos (2000) introduce transactions costs in the foreign sector, but they are also treated as given in the optimization process. 6 See for instance Céspedes et al. (2003, 2004), Cook (2004), Choi and Cook (2004), and Elekdag et al. (2006Elekdag et al. ( , 2007, Guajardo (2008), and Leblebicioglu (2009). 7 Note that, in practice, nonbank rms have also beneted extensively from the cur- rent global excess liquidity conditions, which poses other complex problems of nancial desintermediation, supervision, balance sheet imbalances and risks to nancial instability. ...
We develop a dynamic stochastic model of a middle-income, small open economy with a two-level banking intermediation structure, a risk-sensitive regulatory capital regime, and imperfect capital mobility. Firms borrow from a domestic bank and the bank borrows on world capital markets, in both cases subject to an endogenous premium. A sudden flood in capital flows generates an expansion in credit and activity, and asset price pressures. Countercyclical regulation, in the form of a Basel III-type rule based on real credit gaps, is effective at promoting macroeconomic stability (defined in terms of the volatility of a weighted average of inflation and the output gap) and financial stability (defined in terms of the volatility of a composite index of the nominal exchange rate and house prices). However, because the gain in terms of reduced volatility may exhibit diminishing returns, a countercyclical regulatory rule may need to be supplemented by other, more targeted, macroprudential instruments.
... Tokovi koji imaju svojstva akcijato jest SDI i portfolio akcijski tokovi -ne samo da su smatrani stabilnijim i manje sklonim preokretima, već se smatra i da sa sobom nose mnoge indirektne prednosti finansijske globalizacije kao što su transferi menadžerske i tehnološke 24 Brojni nedavni teorijski radovi su pokušali objasniti vezu između finansijske integracije i relativne volatilnosti rasta potrošnje koja ima oblik grbe. Levchenko (2005) i Leblebicioglu (2006) posmatraju dinamičke modele opšte ravnoteže gde samo pojedini agenti imaju pristup međunarodnim finansijskim tržištima. U oba modela, finansijska integracija dovodi do porasta volatilnosti agregatne potrošnje jer agenti, koji imaju pristup međunarodnim finansijskim tržištima, prestaju učestvovati u aranžmanu podele rizika sa onima koji nemaju takav pristup. ...
Rezime: Literatura o koristima i troškovima finansijske globalizacije za zemlje u razvo- ju je naprasno porasla poslednjih godina, i to kroz mnoge, potpuno različite kanale sa raznovršnošću očigledno konfliktnih rezultata. Još uvek je malo snanih dokaza o rastu- ćim koristima široke liberalizacije kapitalnog računa, ali veći broj skorijih radova u fi- nansijskoj literaturi izveštava da liberalizacije trišta akcija zaista značajno povećavaju rast. Slično tome, dokazi zasnovani na mikroekonomskim (na nivou firme ili industrije) podacima pokazuju određene koristi finansijske integracije i distorzivne efekte kontrola kretanja kapitala, ali makroekonomski dokazi i dalje ne pruaju zaključke. Istovremeno, dok neke studije zauzimaju stav da finansijska globalizacija podstiče makroekonomsku stabilnost zemalja u razvoju, druge tvrde suprotno. Ovaj rad pokušava da prui ujedinjen pojmovni okvir za organizovanje ovako široke i rastuće literature, naročito naglašavajući skorije pristupe merenju katalizatorskih i indirektnih koristi finansijske globalizacije. U suštini, rad ukazuje da su indirektni efekti finansijske globalizacije na razvoj finansij- skog sektora, institucija, vladanje i makroekonomsku stabilnost, po svoj prilici daleko bitniji od bilo kog direktnog uticaja putem akumulacije kapitala ili diversifikacije portfo- lia. Takav pogled objašnjava neuspeh istraivanja zasnovanih na regresijama rasta izme- đu zemalja u pronalaenju pozitivnih efekata finansijske globalizacije, usmeravajući se na novije, potencijalno korisnije i ubedljivije pristupe. Ključne reči: Liberalizacija kapitalnog računa, Finansijska integracija, Rast i volatil- nost, Finansijske krize, Zemlje u razvoju.
... They provide with a clearer view of the behaviour of the time series studied. Thus for example, economists use smoothing techniques to reveal economic trends in data [22]. Smoothing may also deal with missing values, in cases that they are not of high percentage. ...
Data quality is one of the fundamental issues influencing the performance of any data investigation algorithm. Poor data quality always leads to poor quality results. In the investigation chain, the data selection phase is followed by the preprocessing phase, which results in increased data quality, while in parallel it demands the highest time resources of the overall data investigation chain. The preprocessing phase includes the handling of missing data, handling of the outliers, data de-trending and data smoothing. The methods that are used in the preprocessing phase are usually not sufficiently reported in the literature of environmental data analysis and knowledge extraction. The current paper investigates the performance of several methods in all phases of the preprocessing chain of environmental data, by emphasizing in the use of ICT (Information & Communication Technology) methods for the materialization of such preprocessing tasks, and by making use of the air quality as the environmental domain paradigm.
... in highly concentrated among a relatively small share of the population. 4 3 Recent work in open economy macroeconomics relaxes the assumption that all agents have unrestricted financial-market access. In Levchenko (2005), domestic financial markets are underdeveloped, and access to international financial markets is restricted for some households. Leblebicioglu (2008) assumes borrowing frictions in a non-traded goods sector as well as limited access of owners of firms in the non-traded goods sector to international financial markets. The focus of both papers is on explaining the relatively high volatility of consumption in emerging markets. Alvarez et al. (2001) and Occhino (2004) have used the assum ...
Globalization may impose a double-burden on low-skilled workers. On the one hand, the relative supply of low-skilled labor increases. This suppresses wages of low-skilled workers and/or increases their unemployment rates. On the other hand, low-skilled workers typically face more limited access to financial markets than high-skilled workers. This limits their ability to smooth shocks to income intertemporally and to share risks across borders. Using cross-country, industry-level data for the years 1970 - 2004, we document how the volatility of hours worked and of wages of workers at different skill levels has changed over time. We develop a stylized theoretical model that is consistent with the empirical evidence, and we test the predictions of the model. Our results show that greater financial globalization and development increases the volatility of employment, and this effect is strongest for low-skilled workers. A higher share of low-skilled employment has a dampening impact.
Complete financial markets allow countries to share their consumption risks internationally, thereby creating welfare gains through lower volatility of aggregate consumption. Using a panel of 116 countries between 1970 and 2019, I show that a higher share of low‐income households reduces consumption risk sharing, especially so in less‐developed countries. Moreover, I find that a broad range of financial market reforms and financial integration have a positive impact on international consumption risk sharing in poorer developing countries, while in emerging market countries, financial market development, financial reforms, and capital account openness has an impact. In advanced economies, financial (stock and bond) market development as well as financial integration improves international risk sharing. A lack of financial reforms, a lower degree of financial integration and a high share of low‐income households thus contribute to the degree of risk sharing being lower in developing countries than in advanced economies.
We study how financial reforms affect the extent of consumption smoothing in a dynamic stochastic general equilibrium model of an emerging economy. Consistent with the empirical literature and reform efforts in South Korea and South Africa, we emphasize the relation between consumer credit and durable purchases, and model reforms as the relaxation of the collateral constraint on lower income households. We find that the relaxation of the collateral constraint accounts for a substantial share of the decline in consumption smoothing experienced in South Korea and South Africa.
In this paper, we consider the classical problem of maximizing discounted utility, provided that the moment of the next purchase and receipt of a loan is random (Poisson). The purpose of the study is to take into account the uncertain waiting period for receipt of a credit in consumption decision-making. The model is formulated as the problem of optimal stochastic control. The consumer at random moments buys the product at a non-random price and at the same random moments can take and return indefinite loans. For loans, the agent continuously pays interest. He constantly receives dividends in the form of external receipt of money into the account and can accumulate non-interest non-cash money. The optimality conditions are obtained using the Lagrange multiplier method. Sufficient optimality conditions reduce to partial differential equations with variable and unknown delay. They can only be solved by using a combinations of analytic expansions with respect to a small parameter. A special difficulty is the regularization («softening») of the conditions of complementary slackness. As a result, functions were obtained that determine the optimal control of consumption purchases and the size of the loan. One can see how the consumption expenditures change as the end of the planning period approaches. First, consumption depends on money and debt not separately, but on their difference - own means of the consumer. Secondly, far from the planning horizon, consumption is small and grows as the final point in time approaches. This model can be used as part of the description of the consumer agent in dynamic stochastic general equilibrium models. © Publishing House of the Higher School of Economics. All rights reserved.
The purpose of this book is to explore how Korea has managed international capital flows over the last two decades. Unfortunately, less than ten years after Korea had barely recovered from the aftermath of the 1997 Asian financial crisis, the country was hit by yet another crisis, the global financial crisis. There were many causes for these two crises, but international capital flows were prime among them. Therefore, a good understanding of capital flows in and out of Korea during the last two decades is essential to derive some useful lessons from Korea’s experiences. However, before exploring capital flows in Korea, we first provide an overview of international capital flows in general in order to place the Korean case in a broader context.
This book reflects the new diversity of interest in international finance that summarizes and synthesizes developments in the many and varied areas that are now viewed as having international content. The book attempts to differentiate between what is known, what is believed, and what is still being debated about international finance. The book consists of five major topics: (1) exchange rates and risk management, (2) international financial markets and institutions, (3) international investing, (4) international financial management, and (5) special topics. The chapters cover market integration, financial crises, and the links between financial markets and development in some detail as they relate to these areas.
How does access to finance impact consumption volatility? Theory and evidence from advanced economies suggests that greater household access to finance smooths consumption. Evidence from emerging markets, where consumption is usually more volatile than income, indicates that financial reform further increases the volatility of consumption relative to output. This puzzle is addressed in the framework of an emerging economy model in which households face shocks to trend growth rate, and a fraction of them are financially constrained, with no access to financial services. Unconstrained households can respond to shocks to trend growth by raising current consumption more than the rise in current income. Financial reform increases the share of such households, leading to greater relative consumption volatility. Calibration of the model for pre- and post-financial reform in India provides support for the model's key predictions.
The extent of interaction between international capital flows and macro-financial stability is an important and unsettled topic of debate. We contribute to this discussion by providing empirical evidence on the relationship between capital flows and domestic credit growth using a large cross-country panel dataset which includes both developed and developing economies. In the benchmark regression, we use a fixed effect model, and find a statistically significant and positive co-movement between the two variables, which is consistent with common wisdom and recent theory a la Bruno and Shin (2014). This empirical regularity is more pronounced in upper-middle income countries in comparison with the lower-middle and high income countries. The main results are robust to other econometric specifications and a variety of alternative measures for credit growth and capital flows.
Using four rounds (1999, 2002, 2005 and 2008) of the Korean Labor and Income Panel Study, the present paper examines determinants of household income and consumption levels and inequalities. Unconditional as well as conditional stochastic dominance tests are performed by year, by household heads’ characteristics (age, education, gender, health, marital status and occupation) and by household characteristics (household type, household size and degree of urbanization). Mean least squares regression techniques are used to predict conditional expectations. The residuals containing effects for each characteristic conditional on the remaining characteristics are then used for the stochastic dominance analysis employing extended Kolmogorov–Smirnov tests of first-order and second-order dominance in distribution of income and consumption. The results provide a detailed and up-to-date picture of inequality and poverty by subgroup in Korea, which helps in targeting particularly vulnerable groups. While inequality in disposable income is found to be substantial, consumption inequality is less substantial. Households headed by the elderly, the uneducated, the divorced, the widowed, females, and those with health problems are found to be the most vulnerable groups.
Most previous studies mainly focus on the direct impact of financial liberalization on consumption growth volatility with less emphasis on explaining heterogeneity across countries. This paper, therefore, contributes to the existing body of literature by analysing factors which explain such differences. The initial level of inequality and domestic financial development play a prominent role in explaining why the benefit of financial integration differs across countries. Overall, our results, using data from 26 countries, indicate that financial liberalization reduces consumption volatility, ranging between 1.57 and 2.11 (61% to 82%). An increase in the initial level of income inequality by one standard deviation increases consumption volatility, ranging between 0.36 and 0.48 (14% to 19%). Moreover, an increase in one standard deviation of financial development decreases consumption growth variability by 0.16 (6%). Policy measures that promote redistribution and improve domestic financial markets help to reap the potential benefit of financial integration.
Does …nancial liberalization increase consumption smoothing? Yes. This paper develops an empirical framework based on a …rmly grounded theoretical model and provides empirical evidence that more …nancial liberalization improves consumption smoothing. Everything else equal, …nancial liberalization improves consumption smoothing, although in a nonlinear fashion. On the other hand, increased cross-country productivity correlations provide fewer incentives for risk sharing. The extent of consumption risk sharing also depends on the level of impediments to trade in foreign capital. Empirical results show a stronger e¤ect of …nancial liberalization on consumption smoothing for more open economies. I am thankful to Susan Collins, Jonathan Heathcote, Robert Cumby, and Behzad Diba for valuable help and guidance. Any mistakes are my own. I also want to thank Ayhan Kose, Mathew Canzoneri, Jinhui Bai, Carlos Urrutia and participants at Georgetown University Macroeconomic Seminar.
What are the equilibrium effects of trade and capital liberalization on consumption smoothing? This question is addressed by studying the response to productivity shocks in a baseline two country, two goods, incomplete market model, where foreign borrowing is secured by collateral. The paper shows that international financial integration, modeled by relaxing a borrowing constraint a la Kiyotaki in the domestic country, worsens consumption smoothing; international trade integration, modeled by a reduction of non linear iceberg transportation costs, improves it. As a measure of consumption smoothing, the analysis uses the ratio between the simulated standard deviation of consumption growth and the simulated standard deviation of output growth. These results are qualitatively consistent with the empirical evidence provided by Kose, Prasad and Terrones (2003).
This paper studies the effects of financial integration on macroeconomic volatility and welfare. We examine a two-sector(tradable and nontradable), two-country world economy with production in which both stocks and bonds are traded internationally, but markets are incomplete. The effects of integration are examined by comparing the equilibrium properties of the model under three financial configurations: autarky, low integration, and high integration. The model predicts a non-monotonic relationship between the degree of financial integration and the volatility of several macroeconomic variables. Greater integration is initially associated with more volatile consumption and output, but as integration proceeds further volatility declines. We also find that although increasedintegration allows for significantly greater risk sharing between countries, the improvement in welfare can be very small. (JEL: D52,E20, F41) (c) 2007 by the European Economic Association.
A central puzzle in international finance is that real exchange rates are volatile and, in stark contradiction to efficient risk-sharing, negatively correlated with cross-country consumption ratios. This paper shows that a standard international business cycle model with incomplete asset markets augmented with distribution services can account quantitatively for these properties of real exchange rates. Distribution services, intensive in local inputs, drive a wedge between producer and consumer prices, thus lowering the impact of terms-of-trade changes on optimal agents' decisions. This reduces the price elasticity of tradables separately from assumptions on preferences. Two very different patterns of the international transmission of positive technology shocks generate the observed degree of risk-sharing: one associated with improving, the other with deteriorating terms of trade and real exchange rate. In both cases, large equilibrium swings in international relative prices magnify consumption risk due to country-specific shocks, running counter to risk sharing. Suggestive evidence on the effect of productivity changes in U.S. manufacturing is found in support of the first transmission pattern, questioning the presumption that terms-of-trade movements in response to supply shocks invariably foster international risk-pooling.
The authors develop an analytically tractable two-country model that marries a full account of global macroeconomic dynamics to a supply framework based on monopolistic competition and sticky nominal prices. The model offers simple and intuitive predictions about exchange rates and current accounts that sometimes differ sharply from those of either modern flexible-price intertemporal models or traditional sticky-price Keynesian models. The authors' analysis leads to a novel perspective on the international welfare spillovers due to monetary and fiscal policies. Copyright 1995 by University of Chicago Press.
The authors ask whether a two-country business cycle model can account simultaneously for domestic and international aspects of business cycles. With this question in mind, the authors document a number of discrepancies between theory and data. The most striking discrepancy concerns the correlations of consumption and output across countries. In this data, outputs are generally more highly correlated across countries than consumptions. In the model they see the opposite. Copyright 1992 by University of Chicago Press.
In theory, one of the main benefits of financial globalization is that it should allow for more efficient international risk sharing. In this paper, we provide a comprehensive empirical evaluation of the patterns of risk sharing among different groups of countries and examine how international financial integration has affected the evolution of risk sharing patterns. Using a variety of empirical techniques, we conclude that there is at best a modest degree of international risk sharing, and certainly nowhere near the levels predicted by theory. In addition, only industrial countries have attained better risk sharing outcomes during the recent period of globalization. Developing countries have, by and large, been shut out of this benefit. The most interesting result is that even emerging market economies, which have witnessed large increases in cross-border capital flows, have seen little change in their ability to share risk. We find that the composition of flows may help explain why emerging markets have not been able to realize this presumed benefit of financial globalization. In particular, our results suggest that portfolio debt, which has dominated the external liability stocks of most emerging markets until recently, is not conducive to risk sharing.
We provide a new interpretation of the statistical relation between the trade balance and the terms of trade. This relation includes the J-curve, the tendency for trade balances to be negatively correlated with contemporaneous movements in the terms of trade, positively correlated with lagged movements. We document this property in international data and show that it arises, as well, in a two-country stochastic growth model. In the model trade dynamics result, in large part, from fluctuations in investment. A favorable productivity shock in the domestic economy leads to an increase in domestic output, a decrease in its relative price, and a rise in the terms of trade. The increase in domestic productivity also leads to a temporary investment boom. This boom results in an initial trade deficit, followed by future surpluses, and thus a J-curve. We also use the model to provide a new perspective on earlier theories of trade and price dynamics.
This paper examines business cycles theoretically and empirically, with a quantitative study based on data for a cross section of countries. Theoretical concerns indicate that the properties of business cycle models depend not only on important structural aspects of the model, such as money neutrality, labor market structure, and price adjustment, but also on the closure of the model in international markets. Econometric considerations suggest that panel data can provide more information about the country-specific versus universal features of cycles. The authors review business cycle properties in a sample of over a dozen counties in light of these issues.
The authors provide a theoretical interpretation of two features of international data: the countercyclical movements in net exports and the tendency for the trade balance to be negatively correlated with current and future movements in terms of trade but positively correlated with past movements. They document the same properties in a two-country stochastic growth model in which trade fluctuations reflect, in large part, the dynamics of capital formation. The authors find that their general-equilibrium perspective is essential: the relation between the trade balance and the terms of trade depends critically on the source of fluctuations. Copyright 1994 by American Economic Association.
Yes. We construct a measure of aggregate technology change, controlling for aggregation effects, varying utilization of capital and labor, nonconstant returns, and imperfect competition. On impact, when technology improves, input use and nonresidential investment fall sharply. Output changes little. With a lag of several years, inputs and investment return to normal and output rises strongly. The standard one-sector real-business-cycle model is not consistent with this evidence. The evidence is consistent, however, with simple sticky-price models, which predict the results we find: when technology improves, inputs and investment generally fall in the short run, and output itself may also fall. (JEL E22, E32, O33)
This paper develops a computable general equilibrium model in which endogenous agency costs can potentially alter business-cycle dynamics. A principal conclusion is that the agency-cost model replicates the empirical fact that output growth displays positive autocorrelation at short horizons. This hump-shaped output behavior arises because households delay their investment decisions until agency costs are at their lowest--a point in time several periods after the initial shock. Copyright 1997 by American Economic Association.
This paper examines the impact of international financial integration on macroeconomic volatility. Economic theory does not provide a clear guide to the effects of financial integration on volatility, implying that this is essentially an empirical question. We provide a comprehensive examination of changes in macroeconomic volatility in a large group of industrial and developing economies over the period 1960-99. We report two major results: First, while the volatility of output growth has, on average, declined in the 1990s relative to the three earlier decades, we also document that, on average, the volatility of consumption growth relative to that of income growth has increased for more financially integrated developing economies in the 1990s. Second, increasing financial openness is associated with rising relative volatility of consumption, but only up to a certain threshold. The benefits of financial integration in terms of improved risk-sharing and consumption-smoothing possibilities appear to accrue only beyond this threshold.
,We thank our discussants Larry Christiano, Mick Devereux, Fabrizio Perri, C edric Tille, and V. V. Chari, Marty Eichenbaum, Peter Ireland, Paolo Pesenti, Morten Ravn, Sergio Rebelo, Stephanie Schmitt-Groh e, Alan Stockman, Mart n Uribe, along with seminar participants at the AEA meetings, the SED meetings, Boston College, the Canadian Macro Study Group, Duke University, the Ente Einaudi, the European Central Bank, the European University Institute, the Federal Reserve Bank of San Francisco, IGIER, the IMF, New York University, Northwestern University, the University of Pennsylvania, the University of Rochester, the University of Toulouse, the Wharton Macro Lunch group, and the workshop \Exchange rates, Prices and the International Transmission Mechanism" hosted by the Bank of Italy, for many helpful comments and criticism. Corsetti's work on this paper is part of a research network on \The Analysis of International Capital Markets: Understanding Europe's Role in the Global Economy," funded by the European Commission under the Research Training Network Programme (Contract No. HPRN-CT-1999-00067). Part of Dedola's work on this paper was carried out while he was visiting the Department of Economics of the University of Pennsylvania, whose hospitality is gratefully acknowledged. The views expressed here are those of the authors and do not necessarily re ect the positions of the ECB, the Board of Governors of the Federal Reserve System, or any other institution with which the authors are a liated.,Address: Via dei Roccettini 9, San Domenico di Fiesole 50016, Italy; email: Giancarlo. Corsetti@iue. it.,Address: Postfach 16 013 19, D-60066 Frankfurt am Main, Germany; email: luca. dedola@ecb. int.,Address: 20th and C Streets, N. W., Stop 23, Washington, DC 20551, USA; email: Sylvain. Leduc@. frb. gov.
One of the chief benefits of financial liberalization proposed by theoretical literature is that it should allow countries to better smooth consumption through international risk sharing. Recent empirical evidence does not support this prediction. In developing countries, financial liberalization seems to be associated with an increase in consumption volatility. This paper seeks to rationalize the evidence by linking it to two important features of developing countries. First, domestic financial markets are underdeveloped. We model this by adopting the Kocherlakota (1996) framework of risk sharing subject to limited commitment. Second, access to international markets is not available to all members of society. We show that when risks are idiosyncratic, that is, insurable within the domestic economy, opening up to international markets reduces the amount of risk sharing attained at home and raises the volatility of consumption. When risk is aggregate to the economy, the underdeveloped financial system prevents the pooling of aggregate risk across agents for the purposes of insurance in the international markets. Thus, while the volatility of consumption coming from aggregate risk decreases with financial liberalization, it does so by much less than would be predicted by a representative agent model.
This paper presents a multisector dynamic general equilibrium model of business cycles with a distinctive feature: aggregate fluctuations are driven by independent sectoral shocks. The model hypothesizes that trade among sectors provides a strong synchronization mechanism for these shocks due to the limited, but locally intense, interaction that is characteristic of such input trade flows. Limited interaction, characterized by a sparse intermediate input-use matrix, reduces substitution possibilities among intermediate inputs which strengthens comovement in sectoral value-added and leads to a postponement of the law of large numbers in the variance of aggregate value-added. The chief virtue of this model is that reliance on implausible aggregate shocks is not necessary to capture the qualitative features of macroeconomic fluctuations. Building on Horvath, 1998, Review of Economic Dynamics 1, 781–808, which establishes the theoretical foundation for the relevance of limited interaction in the context of a stylized multisector model, this paper specifies a more general multisector model calibrated to the US 2-digit Standard Industrial Code economy. Simulations prove the model is able to match empirical reality as closely as standard one-sector business cycle models without relying on aggregate shocks.
A version of the Kiyotaki and Moore (J. Political Econom. 105 (1997) 211) model of credit cycles is used to examine the extent to which a crisis in a country can spread to another seemingly unrelated country. The model features two small open economies that face credit constraints and produce a differentiated commodity which they export to a large country. A productivity shock to one of the small open economies triggers an adverse terms of trade shock to the other which is then amplified by credit constraints. The paper provides a new perspective on the relationship between terms of trade shocks and the balance of payments that differs from existing models which focus on risk sharing and consumption smoothing. In particular, it is shown that if financial frictions are present, a temporary terms of trade shock can trigger capital outflows and a rapid deterioration in the current account.
This paper assesses the impact of integrating international asset markets when segmented markets are not the only distortion. Using a two-country general equilibrium model with nominal rigidities and monetary shocks, we show that integration is not universally beneficial. Instead, the welfare impact depends on the degree to which exchange rate fluctuations are passed through to consumer prices. While the integration is welfare neutral in the polar cases of complete or zero pass-through, this is not the case when pass-through is partial. When shocks are equally volatile in both countries, integration can be detrimental or beneficial depending on the degree of pass-through. When shocks are more volatile in one country, it benefits from integration compared with the more stable country.
Several papers have documented spurious welfare reversals: incomplete-markets economy produces a higher level of welfare than the complete-markets economy. This paper first demonstrates how conventional linearization can generate approximation errors that can result in welfare reversals. Using a two-country production economy, we argue that spurious welfare reversals are not only possible but also plausible under reasonable values for model parameters. This paper then proposes an approximation method that modifies the conventional linearization by a bias correction. This method can be easily implemented and approximates welfare as accurately as a second-order perturbation method.
This paper introduces a framework for analyzing the role of financial factors as a source of instability in small open economies. Our basic model is a dynamic open economy model with a tradeable good produced with capital and a country-specific factor. We also assume that firms face credit constraints, with the constraint being tighter at a lower level of financial development. A basic implication of this model is that economies at an intermediate level of financial development are more unstable than either very developed or very underdeveloped economies. This is true both in the sense that temporary shocks have large and persistent effects and also in the sense that these economies can exhibit cycles. Thus, countries that are going through a phase of financial development may become more unstable in the short run. Similarly, full capital account liberalization may destabilize the economy in economies at an intermediate level of financial development: phases of growth with capital inflows are followed by collapse with capital outflows. On the other hand, foreign direct investment does not destabilize.
This paper derives a second-order approximation to the solution of a general class of discrete-time rational expectations models. The main theoretical contribution is to show that for any model belonging to that class, the coefficients on the terms linear and quadratic in the state vector in a second-order expansion of the decision rule are independent of the volatility of the exogenous shocks. In addition, the paper presents a set of MATLAB programs that implement the proposed second-order approximation method and applies it to a number of model economies.
We find that in a sample of emerging economies business cycles are more volatile than in developed ones, real interest rates are countercyclical and lead the cycle, consumption is more volatile than output and net exports are strongly countercyclical. We present a model of a small open economy, where the real interest rate is decomposed in an international rate and a country risk component. Country risk is affected by fundamental shocks but, through the presence of working capital, also amplifies the effects of those shocks. The model generates business cycles consistent with Argentine data. Eliminating country risk lowers Argentine output volatility by 27% while stabilizing international rates lowers it by less than 3%.
This paper evaluates the social gains from international risk sharing in some simple general-equilibrium models with output uncertainty. A simulation model calibrated to selected moments of U.S. and Japanese data estimates the incremental loss from a ban on international portfolio diversification to be on the order of 0.20 percent of output per year. Even the theoretical gains from asset trade may disappear under alternative sets of assumptions on preferences and technology. The paper argues that the small magnitude of potential trade gains may help explain the apparently inconsistent findings of empirical studies on the degree of international capital mobility.
This paper discusses whether the integration of international financial markets affects business cycle volatility. In the framework of a new open economy macro-model, we show that the link between financial openness and business cycle volatility depends on the nature of the underlying shock. Empirical evidence supports this conclusion. Our results also show that the link between business cycle volatility and financial openness has not been stable over time.
The authors construct a model of a dynamic economy in which lenders cannot force borrowers to repay their debts unless the debts are secured. In such an economy, durable assets play a dual role: not only are they factors of production but they also serve as collateral for loans. The dynamic interaction between credit limits and asset prices turns out to be a powerful transmission mechanism by which the effects of shocks persist, amplify, and spill over to other sectors. The authors show that small, temporary shocks to technology or income distribution can generate large, persistent fluctuations in output and asset prices. Copyright 1997 by the University of Chicago.
The author provides a selective review of the recent analytical and empirical literature on the benefits and costs of international financial integration. He discusses the impact of financial openness on consumption, investment, and growth, and the impact of foreign bank entry on the domestic financial system. Consistent with some recent studies, the author argues that financial integration must be carefully prepared and managed to ensure that the benefits outweigh the short-run risks. Prudent macroeconomic management, adequate supervision and prudential regulation of the financial system, greater transparency, and improved capacity to manage risk in the private sector are important requirements for coping with potentially abrupt reversals in pro-cyclical, short-term capital flows. The author adopts a more skeptical view than some assessments in two areas, however. First, only foreign direct investment appears to provide dynamic gains and improved prospects for growth; the evidence on the benefits of other types of capital flows remains weak. Second, empirical research on the net benefits associated with foreign bank penetration is far from conclusive; in particular, the possibility that such penetration may lead to adverse changes in the allocation of credit among domestic firms cannot be dismissed on the basis of the existing evidence.
In this paper we document three credit market imperfections prevalent in middle income countries that can help explain the boom-bust cycles as well as other macroeconomic patterns observed at higher frequencies across these countries. These imperfections are: the existence of financing constraints that affect mainly the nontradables sector, currency mismatch and systemic bailout guarantees.
Credit market conditions play a key role in propagating shocks in middle income countries (MICs). In particular, shocks to the spread between domestic and international interest rates have a strong effect on GDP, and an even stronger effect on domestic credit. This strong credit channel is associated with a sharp sectorial asymmetry: the output of the bank-dependent nontradables (N) sector reacts more strongly than tradables (T) output. This asymmetry, in turn, is associated with a strong reaction of the real exchange rate --the relative price between N and T goods. We present a model that reconciles these facts and leads to a well specified estimation framework. From the equilibrium we derive structural VARs that allow us to identify shocks to credit market conditions and trace their effects on the economy. We estimate these structural VARs for a group of MICs and find evidence of a strong credit channel. We argue that at the heart of the MIC credit channel are a deep asymmetry in financing opportunities across N and T sectors, and a severe currency mismatch. This makes movements in the real exchange rate the driving element in the amplification of shocks. Finally, we show that the model's key assumptions are consistent with evidence gleaned from both firm level and aggregate data.
Financial frictions are a central element of most of the models that the literature on emerging markets crises has proposed for explaining the Sudden Stop' phenomenon. To date, few studies have aimed to examine the quantitative implications of these models and to integrate them with an equilibrium business cycle framework for emerging economies. This paper surveys these studies viewing them as ability-to-pay and willingness-to-pay variations of a framework that adds occasionally binding borrowing constraints to the small open economy real-business-cycle model. A common feature of the different models is that agents factor in the risk of future Sudden Stops in their optimal plans, so that equilibrium allocations and prices are distorted even when credit constraints do not bind. Sudden Stops are a property of the unique, flexible-price competitive equilibrium of these models that occurs in a particular region of the state space in which negative shocks make borrowing constraints bind. The resulting nonlinear effects imply that solving the models requires non-linear numerical methods, which are described in the survey. The results show that the models can yield relatively infrequent Sudden Stops with large current account reversals and deep recessions nested within smoother business cycles. Still, research in this area is at an early stage and this survey aims to stimulate further work.
The performance of macroeconomic indicators of capital mobility is examined in the context of an intertemporal equilibrium model of a small open economy. Recursive numerical solution methods are used to compute measures of consumption smoothing, savings-investment correlation, and the variability and output-correlation of investment that characterize the model in the presence of income disturbances. None of these statistics is a reliable indicator of capital mobility unless information regarding differences in preferences, technology, and the nature of stochastic shocks can be taken into account.
This paper examines the impact of international financial integration on macroeconomic volatility in a large group of industrial and developing economies over the period 1960-99. We report two major results: First, while the volatility of output growth has, on average, declined in the 1990s relative to the three preceding decades, we also document that, on average, the volatility of consumption growth relative to that of income growth has increased for more financially integrated developing economies in the 1990s. Second, increasing financial openness is associated with rising relative volatility of consumption, but only up to a certain threshold. The benefits of financial integration in terms of improved risk-sharing and consumption-smoothing possibilities appear to accrue only beyond this threshold.
Theoretical studies have shown that under unorthodox assumptions on preferences and production technologies, collateral constraints can act as a powerful amplification and propagation mechanism of exogenous shocks. We investigate whether or not this result holds under more standard assumptions. We find that collateral constraints typically generate small output amplification. Large amplification is obtained as a "knife-edge" type of result. Copyright 2004 by the Economics Department Of The University Of Pennsylvania And Osaka University Institute Of Social And Economic Research Association.
International financial markets are widely believed to be important for the international transmission of business cycles since they determine the extent to which individuals can smooth consumption in the presence of country-specific shocks to income. Using a two-country equilibrium model with restricted asset trade, the authors find that the absence of complete financial integration may not be important if shocks to national economies have low persistence or are transmitted rapidly across countries. However, if shocks are highly persistent or are not transmitted internationally, the extent of financial integration is central to the international transmission of business cycles. Copyright 1995 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.
This paper examines the relationship between terms of trade and business cycles using a three-sector intertemporal equilibrium model and a large multicountry database. Results show that terms-of-trade shocks account for nearly one-half of actual GDP variability. The model explains weak correlations between net exports and terms of trade (the Harberger, Laursen, and Metzler effect), and produces large and weakly correlated deviations from purchasing power parity and real interest rate parity. Terms-of-trade shocks cause real appreciations and positive interest differentials, although productivity shocks have opposite effects. The puzzle that welfare gains of international asset trading are negligible is left unresolved. Copyright 1995 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.
Business cycles appear to be large, persistent, and asymmetric relative to the shocks hitting the economy. This observation suggests the existence of an asymmetric amplification and propagation mechanism, which transforms the shocks into the observed movements in aggregate output. This article demonstrates, in a small open economy, how credit constraints can be such a mechanism. The article also shows, however, that the quantitative significance of the amplification which credit constraints can provide is sensitive to the quantitative specification of the underlying economy (especially factor shares).
This paper shows that standard international business cycle models can be reconciled with the empirical evidence on the lack
of consumption risk sharing. First, we show analytically that with incomplete asset markets productivity disturbances can
have large uninsurable effects on wealth, depending on the value of the trade elasticity and shock persistence. Second, we
investigate these findings quantitatively in a model calibrated to the U.S. economy. With the low trade elasticity estimated
via a method of moments procedure, the consumption risk of productivity shocks is magnified by high terms of trade and real
exchange rate (RER) volatility. Strong wealth effects in response to shocks raise the demand for domestic goods above supply,
crowding out external demand and appreciating the terms of trade and the RER. Building upon the literature on incomplete markets,
we then show that similar results are obtained when productivity shocks are nearly permanent, provided the trade elasticity
is set equal to the high values consistent with micro-estimates. Under both approaches the model accounts for the low and
negative correlation between the RER and relative (domestic to foreign) consumption in the data—the “Backus-Smith puzzle”.
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.
This paper contributes empirically to our understanding of informed traders. It analyzes traders' characteristics in a foreign exchange electronic limit order market via anonymous trader identities. We use six indicators of informed trading in a cross-sectional multivariate approach to identify traders with high price impact. More information is conveyed by those traders' trades which--simultaneously--use medium-sized orders (practice stealth trading), have large trading volume, are located in a financial center, trade early in the trading session, at times of wide spreads and when the order book is thin.
[eng] We present a two-sided search model where agents differ by their human capital endowment and where workers of different skill are imperfect substitutes. Then the labor market endogenously divides into disjoint segments and wage inequality will depend on the degree of labor market segmentation. The most important results are : 1) overall wage inequality as well as within-group and between-group inequalities increase with relative human capital inequality ; 2) within-group wage inequality decreases while between-group and overall wage inequalities increase with the efficiency of the search process ; 3) within-group, between-group and overall wage inequalities increase with technological changes. [fre] Immigration et justice sociale. . Cet article est d�di� � la m�moire d'Yves Younes qui nous a quitt�s en mai 1996, et dont les derni�res r�flexions sur l'importance du ph�nom�ne migratoire dans les �tats-Unis des ann�es 1980-1790 m'ont beaucoup influenc�.. L'ouverture des fronti�res entre le Nord et le Sud peut-elle se retourner contre les plus d�favoris�s du monde, c'est-�-dire les non-qualifi�s du Sud ?. Avec deux facteurs de production, les migrations Sud-Nord b�n�ficient tou�jours aux moins qualifi�s du Sud, puisqu'ils y sont le facteur le plus abondant. Mais avec trois facteurs de production (trois niveaux de qualifications, ou deux niveaux et un facteur capital imparfaitement mobile), l'ouverture des fronti�res peut conduire � une baisse du salaire des moins qualifi�s du Sud si leur compl�mentarit� avec le travail tr�s qualifi� ou le capital du Nord est suffisamment faible compar�e � celle des sudistes plus qualifi�s.. Plusieurs �tudes r�centes sugg�rent effectivement que les �lasticit�s de compl�mentarit� chutent brutalement au-del� d'un certain �cart de qualification. Cependant, rien ne prouve que ces effets soient suffisamment forts pour que l'ouverture optimale des fronti�res du point de vue de la justice sociale
We present a two-country, two-good model in which there do not exist any markets for international trade in financial assets. We compare the predictions of this model to those of two other models, one in which markets are complete and a second in which a single non-contingent bond is traded. We find that only the financial autarky model can generate volatility in the terms of trade similar to that in data for floating rate period and, at the same time, account for observed cross-country output, consumption, investment and employment correlations. We interpret our findings as evidence that the extent of international borrowing and lending opportunities is important for the international business cycle.
Trade on international financial markets allows people to insure country-specific risk and smooth consumption intertemporally. Equilibrium models of business cycles with trade on global financial markets typically yield international consumption correlations near one and excessive volatility of investment. The authors incorporate nontraded goods in the model and find that the implications for aggregate consumption, investment, and the trade balance are consistent with business-cycle properties of industrialized countries. However, the model driven by technology shocks alone yields counterfactual implications for comovements between consumption and prices at the sectoral level. Taste shocks produce price-quantity relationships more consistent with the data. Copyright 1995 by American Economic Association.
We develop a two-country, optimising, sticky prices and sticky wages model of real exchange rate determination in the new open macroeconomics tradition to analyse the interaction between supply-side behaviour, market structure and the real exchange rate. For a UK-euro area calibration, supply-side improvements to total factor productivity (TFP) or the degree of monopolistic competition in the goods and labour markets result in a depreciation of the real exchange rate. When TFP increases in the traded goods sector, a depreciation of the terms of trade offsets the appreciation of the relative price of non-traded goods, contrasting with the Balassa-Samuelson proposition. Copyright Royal Economic Society 2003
This chapter develops a dynamic general equilibrium model that is intended to help clarify the role of credit market frictions in business fluctuations, from both a qualitative and a quantitative standpoint. The model is a synthesis of the leading approaches in the literature. In particular, the framework exhibits a "financial accelerator", in that endogenous developments in credit markets work to amplify and propagate shocks to the macroeconomy. In addition, we add several features to the model that are designed to enhance the empirical relevance. First, we incorporate money and price stickiness, which allows us to study how credit market frictions may influence the transmission of monetary policy. In addition, we allow for lags in investment which enables the model to generate both hump-shaped output dynamics and a lead-lag relation between asset prices and investment, as is consistent with the data. Finally, we allow for heterogeneity among firms to capture the fact that borrowers have differential access to capital markets. Under reasonable parametrizations of the model, the financial accelerator has a significant influence on business cycle dynamics.
Since the seminal papers of Kydland and Prescott (1982) and King, Plosser and Rebelo (1988), it has become commonplace in macroeconomics to approximate the solution to nonlinear, dynamic general equilibrium models using linear methods. Linear approximation methods are useful to characterize certain aspects of the dynamic properties of complicated models. First-order approximation techniques are not however, well suited to handle questions such as welfare comparisons across alternative stochastic of policy environments. The problem with using linearized decision rules to evaluate second-order approximations to the objective function is that some second-order terms of the objective function are ignored when using a linearized decision rule. Such problems do not arise when the policy function is approximated to second-order or higher. In this paper we derive a second order approximation to the policy function of a dynamic, rational expectations model. Our approach follows the perturbation method described in Judd (1998) and developed further by Collard and Juillard(2001). We follow Collard and Juillard closely in notation and methodology. An important difference separates this Paper from the work of Collard and Juillard. Namely, Collard and Juillard apply what they call a bias reduction procedure to capture the fact that the policy function depends on the variance of the underlying shocks. Instead, we explicitly incorporate a scale parameter for the variance of the exogenous shocks as an argument of the policy function. In approximating the policy function, we take a second order Taylor expansion with respect to the state variables as well as this scale parameter. To illustrate its applicability, the method is used to solve the dynamics of a simple neoclassical model. The Paper closes with a brief description of a set of MATLAB programs designed to implement the method.
We examine the effects of both equity market liberalization and capital account openness on real consumption growth variability. We show that financial liberalization is mostly associated with lower consumption growth volatility. Our results are robust, surviving controls for business-cycle effects, economic and financial development, the quality of institutions, and other variables. Countries that have more open capital accounts experience a greater reduction in consumption growth volatility after equity market openings. The results hold for both total and idiosyncratic consumption growth volatility. We also find that financial liberalizations are associated with declines in the ratio of consumption growth volatility to GDP growth volatility, suggesting improved risk sharing. Our results are weaker for liberalizing emerging markets but we never observe a significant increase in real volatility. Moreover, we demonstrate significant differences in the volatility response depending on the size of the banking and government sectors and certain institutional factors.
The process of financial market integration is modeled in an intertemporal general equilibrium framework as the elimination of trading frictions between financial markets in different countries. Goods markets are assumed to be imperfectly competitive and goods prices are subject to sluggish adjustment. Simulation experiments show that increasing financial market integration increases the volatility of a number of variables when shocks originate from the money market but decreases the volatility of most variables when shocks originate from real demand or supply. Copyright 1996 by The editors of the Scandinavian Journal of Economics.
This is a version of the program used in David Backus, Patrick Kehoe and Finn Kydland, "Dynamics of the Trade Balance and the Terms of Trade: The J-Curve?," American Economic Review, vol. 84, pp. 84-103, Mar. 1994 The parameter values have to be specified in a separate file.
This paper develops a simple neoclassical model of the business cycle in which the condition of borrowers' balance sheets is a source of output dynamics. The mechanism is that higher borrower net worth reduces the agency costs of financing real capital investments. Business upturns improve net worth, lower agency costs, and increase investment, which amplifies the upturn; vice versa, for downturns. Shocks that affect net worth (as in a debt-deflation) can initiate fluctuations. Copyright 1989 by American Economic Association.
Can sticky prices explain the persistence and volatility of real exchange rate
- V V Chari
- P J Kehoe
- E R Mcgrattan
Chari, V.V., Kehoe, P.J., McGrattan, E.R., 2001. Can Sticky Prices Explain the Persistence
and Volatility of Real Exchange Rate. Federal Bank of Minneapolis Staff Report 227.
- P Lane
- G M Milesi-Ferretti
Lane, P., Milesi-Ferretti, G.M., 2002. International Financial Integration. IMF, working paper.