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Working Paper
Explaining International Business Cycle Synchronization: Recursive Preferences and the Terms of Trade Channel
The business cycles of advanced economies are synchronized. Standard macro models fail to explain that fact. This paper presents a simple model of a two-country, two-traded good, complete-financial-markets world in which country-specific productivity shocks generate business cycles that are highly correlated internationally. The model assumes recursive intertemporal preferences (Epstein-Zin-Weil), and a muted response of labor hours to household wealth changes (due to Greenwood-Hercowitz-Huffman period utility and demand-determined employment under rigid wages). Recursive intertemporal ...
Working Paper
Euro Area and U.S. External Adjustment: The Role of Commodity Prices and Emerging Market Shocks
The trade balances of the Euro Area (EA) and of the U.S. have improved markedly after the Global Financial Crisis. This paper quantifies the drivers of EA and U.S. economic fluctuations and external adjustment, using an estimated (1999-2017) three-region (U.S., EA, rest of world) DSGE model with trade in manufactured goods and in commodities. In the model, commodity prices reflect global demand and supply conditions. The paper highlights the key contribution of the post-crisis collapse in commodity prices for the EA and U.S. trade balance reversal. Aggregate demand shocks originating in ...
Working Paper
Rational Bubbles in Non-Linear Business Cycle Models: Closed and Open Economies
This paper studies rational bubbles in non-linear dynamic general equilibrium models of the macroeconomy. The term ‘rational bubble’ refers to multiple equilibria due to the absence of a transversality condition (TVC) for capital. The lack of TVC can be due to an OLG population structure. If a TVC is imposed, the macro models considered here have a unique solution. Bubbles reflect self-fulfilling fluctuations in agents’ expectations about future investment. In contrast to explosive rational bubbles in linearized models (Blanchard (1979)), the rational bubbles in non-linear models here ...
Working Paper
International capital flows and the boom-bust cycle in Spain
We study the joint dynamics of foreign capital flows and real activity during the recent boom- bust cycle of the Spanish economy, using a three-country New Keynesian model with credit- constrained households and firms, a construction sector and a government. We estimate the model using 1995Q1-2013Q2 data for Spain, the rest of the Euro Area (REA) and the rest of the world. We show that falling risk premia on Spanish housing and non-residential capital, a loosening of collateral constraints for Spanish households and firms, as well as a fall in the interest rate spread between Spain and the ...
Working Paper
International portfolios, capital accumulation and foreign assets dynamics
Despite the liberalization of capital flows among OECD countries, equity home bias remains sizable. We depart from the two familiar explanations of equity home bias: transaction costs that impede international diversification, and terms of trade responses to supply shocks that provide risk sharing, so that there is little incentive to hold diversified portfolios. We show that the interaction of the following ingredients generates a realistic equity home bias: capital accumulation, shocks to the efficiency of physical investment, as well as international trade in stocks and bonds. In our ...
Working Paper
Global banks, financial shocks and international business cycles: evidence from an estimated model
This paper estimates a two-country model with a global bank, using U.S. and Euro area (EA) data, and Bayesian methods. The estimated model matches key U.S. and EA business cycle statistics. Empirically, a model version with a bank capital requirement outperforms a structure without such a constraint. A loan loss originating in one country triggers a global output reduction. Banking shocks matter more for EA macro variables than for U.S. real activity. During the Great Recession (2007?09), banking shocks accounted for about 20 percent of the fall in U.S. and EA GDP, and for more than half of ...
Discussion Paper
Fiscal policy, productivity shocks, and the U.S. trade balance deficit
A two-country Real Business Cycle (RBC) model is used to study the behavior of the United States trade balance. In this model, economic fluctuations are driven by productivity shocks and by variations in government purchases and in distorting taxes. The model is simulated using quarterly data on total factor productivity, government purchases, and the average tax rate in the seven major industrial countries during the period 197591. A version of the model that postulates complete international asset marketsas frequently assumed in the International RBC literature (see, e.g., Backus, Kehoe, ...
Working Paper
The post-crisis slump in the Euro Area and the US: evidence from an estimated three-region DSGE model
The global financial crisis (2008-09) led to a sharp contraction in both Euro Area (EA) and US real activity, and was followed by a long-lasting slump. However, the post-crisis adjustment in the EA and the US shows striking differences?in particular, the EA slump has been markedly more protracted. We estimate a three-region (EA, US and Rest of World) New Keynesian DSGE model (using quarterly data for 1999-2014) to quantify the drivers of the divergent EA and US adjustment paths. Our results suggest that financial shocks were key drivers of the 2008-09 Great Recession, for both the EA and the ...
Working Paper
Risk sharing in a world economy with uncertainty shocks
This paper analyzes the effects of output volatility shocks and of risk appetite shocks on the dynamics of consumption, trade flows and the real exchange rate, in a two-country world with recursive preferences and complete financial markets. When the risk aversion coefficient exceeds the inverse of the intertemporal substitution elasticity, then an exogenous rise in a country?s output volatility triggers a wealth transfer to that country, in equilibrium; this raises its consumption, lowers its trade balance and appreciates its real exchange rate. The effects of risk appetite shocks resemble ...
Working Paper
Tractable latent state filtering for non-linear DSGE models using a second-order approximation
This paper develops a novel approach for estimating latent state variables of Dynamic Stochastic General Equilibrium (DSGE) models that are solved using a second-order accurate approximation. I apply the Kalman filter to a state-space representation of the second-order solution based on the ?pruning? scheme of Kim, Kim, Schaumburg and Sims (2008). By contrast to particle filters, no stochastic simulations are needed for the filter here--the present method is thus much faster. In Monte Carlo experiments, the filter here generates more accurate estimates of latent state variables than the ...