DP3096 Closing Small Open Economy Models

Author(s): Stephanie Schmitt-Grohé, Martín Uribe
Publication Date: January 2002
Keyword(s): complete and incomplete asset markets, small open economy, stationarity
JEL(s): F41
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3096

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.