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Title: Closing Small Open Economy Models

Author(s): Stephanie Schmitt-Grohé and Martín Uribe

Publication Date: January 2002

Keyword(s): complete and incomplete asset markets, small open economy and stationarity

Programme Area(s): International Macroeconomics

Abstract: 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.

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Bibliographic Reference

Schmitt-Grohé, S and Uribe, M. 2002. 'Closing Small Open Economy Models'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=3096