Creator: Arellano, Cristina, Bai, Yan, and Mihalache, Gabriel Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 555 Abstract:
Sovereign debt crises are associated with large and persistent declines in economic activity, disproportionately so for nontradable sectors. This paper documents this pattern using Spanish data and builds a two-sector dynamic quantitative model of sovereign default with capital accumulation. Recessions are very persistent in the model and more pronounced for nontraded sectors because of default risk. An adverse domestic shock increases the likelihood of default, limits capital inﬂows, and thus restricts the ability of the economy to exploit investment opportunities. The economy responds by reducing investment and reallocating capital toward the traded sector to support debt service payments. The real exchange rate depreciates, a reﬂection of the scarcity of traded goods. We ﬁnd that these mechanisms are quantitatively important for rationalizing the experience of Spain during the recent debt crisis.
Keyword: Capital accumulation, Traded and nontraded production, Sovereign default with production economy, Real exchange rate, and European debt crisis Subject (JEL): E30 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data) and F30 - International Finance: General
Creator: Chahrour, Ryan and Stevens, Lacramioara Luminita Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 522 Abstract:
We develop a model of equilibrium price dispersion via retailer search and show that the degree of market segmentation within and across countries cannot be separately identified by good-level price data alone. We augment a set of well-known empirical facts about the failure of the law of one price with data on aggregate intranational and international trade quantities, and calibrate the model to match price and quantity facts simultaneously. The calibrated model matches the data very well and implies that within-country markets are strongly segmented, while international borders contribute virtually no additional market segmentation.
Keyword: Law of one price, Border effect, and Real exchange rate Subject (JEL): F41 - Open Economy Macroeconomics, E30 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data), and F30 - International Finance: General
Creator: Kehoe, Timothy Jerome, 1953-, Ruhl, Kim J., and Steinberg, Joseph B. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 489 Abstract:
Since the early 1990s, as the United States borrowed heavily from the rest of the world, employment in the U.S. goods-producing sector has fallen. We construct a dynamic general equilibrium model with several mechanisms that could generate declining goods-sector employment: foreign borrowing, nonhomothetic preferences, and differential productivity growth across sectors. We find that only 15.1 percent of the decline in goods-sector employment from 1992 to 2012 stems from U.S. trade deficits; most of the decline is due to differential productivity growth. As the United States repays its debt, its trade balance will reverse, but goods-sector employment will continue to fall.
Keyword: Global imbalances, Structural change, and Real exchange rate Subject (JEL): O41 - One, Two, and Multisector Growth Models, F34 - International Lending and Debt Problems, and E13 - General Aggregative Models: Neoclassical
Creator: Heathcote, Jonathan and Perri, Fabrizio Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 480 Abstract:
This chapter is structured in three parts. The first part outlines the methodological steps, involving both theoretical and empirical work, for assessing whether an observed allocation of resources across countries is efficient. The second part applies the methodology to the long-run allocation of capital and consumption in a large cross section of countries. We find that countries that grow faster in the long run also tend to save more both domestically and internationally. These facts suggest that either the long-run allocation of resources across countries is inefficient, or that there is a systematic relation between fast growth and preference for delayed consumption. The third part applies the methodology to the allocation of resources across developed countries at the business cycle frequency. Here we discuss how evidence on international quantity comovement, exchange rates, asset prices, and international portfolio holdings can be used to assess efficiency. Overall, quantities and portfolios appear consistent with efficiency, while evidence from prices is difficult to interpret using standard models. The welfare costs associated with an inefficient allocation of resources over the business cycle can be significant if shocks to relative country permanent income are large. In those cases partial financial liberalization can lower welfare.
Keyword: Long-run risk, Long-run growth, International business cycles, International risk sharing, and Real exchange rate Subject (JEL): F41 - Open Economy Macroeconomics and F36 - Financial Aspects of Economic Integration
Creator: Kehoe, Timothy Jerome, 1953- and Ruhl, Kim J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 414 Abstract:
A sudden stop of capital flows into a developing country tends to be followed by a rapid switch from trade deficits to surpluses, a depreciation of the real exchange rate, and decreases in output and total factor productivity. Substantial reallocation takes place from the nontraded sector to the traded sector. We construct a multisector growth model, calibrate it to the Mexican economy, and use it to analyze Mexico's 1994–95 crisis. When subjected to a sudden stop, the model accounts for the trade balance reversal and the real exchange rate depreciation, but it cannot account for the decreases in GDP and TFP. Extending the model to include labor frictions and variable capital utilization, we still find that it cannot quantitatively account for the dynamics of output and productivity without losing the ability to account for the movements of other variables.
Keyword: Developing country crisis, Real exchange rate, Sudden stop, Total factor productivity, Nontradable, Mexico, and Tradable Subject (JEL): F43 - Economic Growth of Open Economies, F34 - International Lending and Debt Problems, O41 - One, Two, and Multisector Growth Models, O47 - Empirical Studies of Economic Growth; Aggregate Productivity; Cross-Country Output Convergence, F32 - Current Account Adjustment; Short-term Capital Movements, F21 - International Investment; Long-term Capital Movements, E21 - Macroeconomics: Consumption; Saving; Wealth, and O54 - Economywide Country Studies: Latin America; Caribbean
Creator: Atkeson, Andrew and Burstein, Ariel Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 404 Abstract:
International relative prices across industrialized countries show large and systematic deviations from relative purchasing power parity. We embed a model of imperfect competition and variable markups in a quantitative model of international trade. We find that when our model is parameterized to match salient features of the data on international trade and market structure in the US, it can reproduce deviations from relative purchasing power parity similar to those observed in the data because firms choose to price-to-market. We then examine how pricing-to-market depends on the presence of international trade costs and various features of market structure.
Keyword: Real exchange rate, Exchange-rate pass-through, Pricing-to-market, Purchasing power parity, and Terms of trade Subject (JEL): F31 - Foreign Exchange, F14 - Empirical Studies of Trade, and F12 - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
Creator: Kocherlakota, Narayana Rao, 1963- and Pistaferri, Luigi Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 372 Abstract:
Typical incomplete markets models in international economics make two assumptions. First, households are not able to fully insure themselves against country-specific shocks. Second, there is a representative household within each country, so that households are fully insured against idiosyncratic shocks. We assume instead that cross-household risk-sharing is limited within countries, but cross-country risk-sharing is complete. We consider two types of limited risk-sharing: domestically incomplete markets (DI) and private information-Pareto optimal (PIPO) risk-sharing. We show that the models imply distinct restrictions between the cross-sectional distributions of consumption and real exchange rates. We evaluate these restrictions using household-level consumption data from the United States and the United Kingdom. We show that the PIPO restriction fits the data well when households have a coefficient of relative risk aversion of around 5. The analogous restrictions implied by the representative agent model and the DI model are rejected at conventional levels of significance.
Keyword: Market incompleteness, Real exchange rate, Precautionary savings, and Pareto optimality Subject (JEL): E21 - Macroeconomics: Consumption; Saving; Wealth, F31 - Foreign Exchange, and D63 - Equity, Justice, Inequality, and Other Normative Criteria and Measurement