Closing Small Open Economy Models

21 Pages Posted: 11 Oct 2002

See all articles by Stephanie Schmitt-Grohé

Stephanie Schmitt-Grohé

Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Martín Uribe

Columbia University - Graduate School of Arts and Sciences - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: October 2002

Abstract

The small open economy model with incomplete asset markets features a steady state that depends on initial conditions and equilibrium dynamics that possess 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; and (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.

Suggested Citation

Schmitt-Grohe, Stephanie and Uribe, Martin, Closing Small Open Economy Models (October 2002). NBER Working Paper No. w9270, Available at SSRN: https://ssrn.com/abstract=338876

Stephanie Schmitt-Grohe (Contact Author)

Centre for Economic Policy Research (CEPR) ( email )

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Martin Uribe

Columbia University - Graduate School of Arts and Sciences - Department of Economics ( email )

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