Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?

I build a symmetric two-country model that incorporates nominal rigidities, local-currency pricing and monopolistic competition distorting the goods markets. The model is similar to the framework developed in Søndergaard (2008a, 2008b), but it also introduces frictions in the assets markets by restricting the financial assets available to two uncontingent nominal bonds in zero-net supply and by adding quadratic costs on international borrowing (see, e.g., Benigno and Thoenissen (2008) and Benigno (2009). The technical part of the paper contains three basic calculations. First, I derive the equilibrium conditions of the open economy model under local-currency pricing and incomplete asset markets. Second, I compute the zero-inflation (deterministic) steady state and discuss what happens with a non-zero net foreign asset position. Third, I derive the log-linearization of the equilibrium conditions around the deterministic steady state. The quantitative part of the paper aims to give a broad overview of the role that incomplete international asset markets can play in accounting for the persistence and volatility of the real exchange rate. I find that the simulation of the incomplete and complete asset markets models is almost indistinguishable whenever the business cycle is driven primarily by either non-persistent monetary or persistent productivity (but not permanent) shocks. In turn, asset market incompleteness has more sizeable wealth effects whenever the cycle is driven by persistent (but not permanent) investment-specific technology shocks, resulting in significantly lower real exchange rate volatility.

Section: Other Relationshipsmentioning

confidence: 99%

A Redux of the Workhorse NOEM Model with Capital Accumulation and Incomplete Asset Markets

Martínez‐García

2011

“…Taxes are assumed to be constant 12 ; transfers react to the debt-to-GDP ratio to ensure long-run …scal solvency:…”

Section: The Governmentmentioning

confidence: 99%

“…More speci…cally, each of the two central banks follows the rule given by (12), with the same calibration as in the benchmark speci…cation. Asset markets are again incomplete, with domestic residents paying a premium (which depends on their international portfolio) over the foreign rate i t .…”

Section: Independent Monetary Policiesmentioning

confidence: 99%

Welfare Implications of Country Size in a Monetary Union

Mykhaylova

2008

This paper calculates di¤erences in welfare costs of nominal rigidities in large and small EMU countries. I use a two-country DSGE model characterized by optimizing agents, monopolistic wage and price setting, distortionary taxes and government debt dynamics. I …nd that these costs are virtually identical for all members of the EMU, and small countries are not at a disadvantage when it comes to the setting of the common monetary policy. This conclusion is primarily due to highly correlated technological processes in Europe, which cause national and Euro-wide in ‡ations to move together. These …ndings are robust to the asset market structure, trade openness, and di¤erent speci…cations of the Taylor rule.

“…Chari, Kehoe and McGrattan (2002), in their attempts to determine whether sticky prices can lead to volatile and persistent real exchange rate movements, for example, assume in one experiment that the utility from consumption depends not on current consumption but rather on its level relative to a fraction of last period's aggregate consumption. A similar formulation has also been used by Campbell andCochrane (1999), Carroll, Overland, andWeil (2000), and Ravn, Schmitt-Grohe, In what follows, we show that loss aversion can also increase savings, but only if consumption would otherwise have fallen below the reference trigger.…”

Section: Loss Aversion With a Complete Set Of Arrow Securitiesmentioning

confidence: 99%

Fear and Market Failure: Global Imbalances and “Self-Insurance”

Miller

Zhang

2007

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. The views and interpretations in this document are those of the authors and should not be attributed to the Inter-American Development Bank, or to any individual acting on its behalf. This paper may be freely reproduced provided credit is given to the Research Department, InterAmerican Development Bank. Terms of use: Documents inThe Research Department (RES) produces a quarterly newsletter, IDEA (Ideas for Development in the Americas), as well as working papers and books on diverse economic issues. To obtain a complete list of RES publications, and read or download them please visit our web site at: http://www.iadb.org/res. 3 Abstract 1This paper proposes an integrated framework to analyze jointly two key issues: the emergence of global imbalances and the precautionary motive for accumulating reserves. Standard models of general equilibrium would predict modest current account surpluses in the emerging markets if they face higher risk than the US itself. But, with pronounced Loss Aversion in emerging markets, their precautionary savings can generate substantial "global imbalances," especially if there is an inefficient supply of global "insurance." In principle, lower real interest rates will ensure that aggregate demand equals supply at a global level (though the required real interest may be negative). While a precautionary savings glut appears to be a temporary phenomenon, a process of correction triggered by a "Sudden Stop" in capital flows to the United States might lead to a "hard landing." JEL Classification: D51, D52, E12, E13, E21, E44, F32.