Small Open Economy Model

In line with the current tools used in analyzing open economy issues, this paper tilts toward the small open economy (SOE) model. Galí and Monacelli’s (2005) SOE model or its simplification by Lubik and Schorfheide (2005) has become standard and vastly used in the literature. This model is a variant of the dynamic stochastic general equilibrium (DSGE) model and derives from the first principle by explicitly modelling the household and firm behaviour as well as the monetary authority’s reaction function while at same time incorporating the foreign economy. Thus, it is robust against the well-known Lucas (1976) critique, and a good model for policy analysis. The version of the model adopted for this exercise is Lubik and Schorfheide’s (2006) which has been applied by other authors for other economies. One of the unique strands of this paper, therefore, is the explicit modelling of the optimal choices made by economic agents in Nigeria. Central banks around the world overwhelmed by the helicopter’s view of this modelling approach are already building versions of the DSGE models and it will not be out of place to reckon with Nigeria.

Some studies also explore the implications of home production for international busi- ness cycles, but these studies mostly focus on two large countries. Canova and Ubide (1998) show that technology shocks in the home sector can generate volatile terms of trade observed in data. Karabarbounis (2014) …nds that the presence of home production can generate countercyclical labor wedges, a negative correlation between relative market consumption and the terms of trade (i.e., the “Backus and Smith puzzle” pointed out by Backus and Smith (1993)), and the empirical pattern that market output correlates more than market consumption across countries (i.e., the “quantity anomaly” pointed out by Backus et al. (1994)). To sum up, Canova and Ubide (1998) and Karabarbounis (2014) contribute to the literature by showing that the introduction of home production to two- country RBC models is helpful in explaining international business cycles. In contrast to these studies, this paper sets up a small open economy model with home production and uses it to discuss how the presence of home production helps to explain the di¤er- ences between developed economies and emerging markets in the empirical patterns of international business cycles.

separable government consumption, financed by means of lump-sum taxes, in the utility function. Extending the model to a small open economy case complicates the problem for monetary policy to the extent that the authorities must additionally take into account how the exchange rate affects other macroeconomic variables. Similar to the closed-economy case, we are able to derive an optimal monetary policy rule which takes into account developments in government consumption, in addition to developments in the rest of the world economy. The other extension that this paper adds to the canonical small open economy model is modelling the rest of the world economy as an aggregate of identical small open economies, and each of them has a size of zero, following the work of Unalmis et al. 2008. This will allow us to trace the spillover effects of supply and demand shocks in the foreign economy on the domestic economy. I choose this framework over the two-country model, adopted in (Obstfeld and Rogoff 1995; 1996) and Ganelli 2003, to prevent spillovers from the domestic economy to the rest of the world economy that might complicate the analysis.

Our purpose here is to introduce a foreign sector to the model studied by Jermann 4 (1998), and to allow in this way the representative household to have a financial access to the foreign economy. Incorporating the foreign sector will give another opportunity to households to smooth their consumptions. We develop a framework combining the loglinear reduced form along the lines of King, Plosser and Rebelo (1988) and the asset pricing formulae based on the lognormality of the distribution introduced by Hansen and Singleton (1983) and more recently by Campbell (1986 and 1996). This can essentially allow us, to study the behavior of the equity premium, in the case of small open economy model, with habit persistence in preferences and adjustment costs of capital. Thus, with this in mind, we study the business cycle and assets pricing implications of the model and whether see if the results obtained by the preceding studies, 5 and their finding hold once the foreign economy is introduced in the model.

modification, several assessment techniques are used. The empirical analysis suggests that (i) the presence of the cost channel and the UIP modification improves the model fit, (ii) though there is evidence of the cost channel, its strength is not sufficient to reproduce the price puzzle, and (iii) the standard UIP condition is violated in Australia and the presented UIP modification potentially resolves the delayed overshooting puzzle. Chapter 3 examines the importance of news shocks in an estimated small open economy model for analysing business cycle properties of macroeconomic aggregates, including labour market variables. The chapter contributes to the existing literature on the news- driven business cycle in several ways. In particular, the chapter provides one of the first attempts to empirically assess (i) the international transmission mechanism of news shocks and (ii) the relevance of news shocks in generating exchange rate and labour market fluctuations using Bayesian open economy New Keynesian DSGE model in an international setting. Moreover, as a novelty in the literature, the chapter allows that news horizon(s) for each structural shock can be different depending on best-fitting searching results based on the approach originally proposed by Fujiwara et al. (2011). In Chapter 3, the model in Chapter 2 is further extended to include labour market imperfection, and both unanticipated and news shocks drive the extended model. The model is fitted to data for Australia and the US. Bayesian methods are employed to estimate the role of the news shocks and evaluate the model’s empirical properties. The main results show that the estimated model is able to qualitatively replicate the existing results of the VAR analyses on news-driven business cycles (e.g., Kosaka 2013 and Kamber et al. 2014), and news

This paper studies the welfare effects of a consumption tax rise based on the two-sector small open economy model of Obstfeld and Rogoff (1995) and Lane (1997). The main findings of our analysis are that 1) in the case of free trade, the consumption tax rise has no effect on welfare, 2) when there is the nontraded goods sector, the consumption tax rise has a negative effect on welfare, and 3) the larger the share of nontraded goods in consumption is, the larger the negative welfare effect of consumption tax will be.

We build a small open economy model with net commodity exports that features search and matching frictions in the labour market as proposed by Diamond (1982), Mortensen (1982), and Pissarides (1985) (DMP) to obtain an economic interpretation of these empirical findings. In departure from most of the search and matching literature preferences over consumption and labour are specified as in Greenwood et al. (1988) to allow for a consumption differential between employed and unemployed agents. Wages are determined by Nash bargaining between firms and workers. To keep matters simple, all goods are traded and commodity production is fixed in our baseline model. We proceed to show that, conditional on commodity price shocks, this type of model is capable of generating data congruent labour market dynamics. Since our identification scheme easily identifies commodity price shocks in the data, the results from estimating the PVAR provide a clean yardstick against which to assess the performance of the theoretical model through impulse response function matching. This exercise yields estimates of key structural model parameters with implications for the consumption differential between employed and unemployed agents and the degree of international risk sharing through financial markets.

with dashes, diamonds, no dashes or shapes, circles and asterisks) and total deposits. Both panels suggest that disaggregated welfare changes are highly non-linear and non-monotonic in contrast with the steady state analysis. The left panel illustrates the reversal of welfare changes in Economy 1. Consumers who are poor both in terms of earnings and total deposit positions enjoy substantial welfare gains thanks to persistently high redistributive transfers along the transition. Furthermore, welfare gains of the rich now start from a low level and are not increasing in total deposits position anymore. This is due to the limited increase in rich individuals’ consumption, because, gradual decline of transfers produce diminished wealth effects. On the other hand, in Economy 2, welfare gains of the earnings poor increases for low deposits levels. This explains why median gain is the largest in the fourth column of table 3. Earnings rich individuals finance more of the fiscal spending with their inflation tax payments. Therefore, their welfare gains from disinflation are larger. But now, wealth effects of reducing spending is again spilled over time, which produces diminishing welfare gains in total deposits. This completes the analysis of macroeconomic, distributional and welfare consequences of transitional dynamics of disinflation. It should be obvious at this point that accounting for gradual disinflation (which is observed in the data) improves this stylized model of small open economy with heterogeneous agents upon the steady state comparisons in three dimensions: First, stylized dynamics of consumption velocity and money demand during disinflation periods are captured better. Second, it shows that the path of financial assets inequality can be volatile along disinflation and third, welfare consequences are substantially different than those implied by steady state comparisons. Therefore, I argue that the most relevant sensitivity experiment within this framework would be to focus on the importance of calibrating the path of “gradual disinflation”. Consequently, in the next section, I perform sensitivity analysis by computing the transitional dynamics equilibrium, which now entails a stabilization policy of unanticipated “sudden” decline in inflation.

The traditional SCP way of examining the determinants of concentration was to include several variables together in a regression model for concentration (see e.g. Davies, 1989). These variables typically included advertising intensity and/or R&D intensity, measures of barriers to entry, and often also export and import shares. In the bounds approach the model is estimated separately for different types of industries without including R&D or advertising as explanatory variables. One purpose of this paper is to examine whether some of the “traditional” variables could still be used for explaining how far different industries are from the lower bound. If there are factors that influence the competitive situation, entry etc. in the markets, they could be potential determinants of the position of the industries in the concentration - market size space. Note that this is different from saying that in the low sunk cost industries high and low competition industries should have different limiting levels of concentration. Below we define the high/low competition distinction of the low sunk cost industries and the corresponding bounds on the basis of imports. The industries may, however, differ systematically from these bounds if they have differences in the ease of domestic entry, for example. Technically, we estimate the model as a stochastic frontier, where the explanatory factors are included in the mean and variance of a truncated error term. These explanatory variables include export intensity and alternative measures of entry barriers.

From the point of view of political practice is appropriate to seek a model that reached a quality prediction performance for all the variables. The above results show that for example, in predicting GDP growth is the best prediction performance DSGE model, however, in predicting infl ation gives the best performance Bayesian VAR model Littermann’s priori density. From the point of view of multivariate statistics is best assessed DSGE model, which is probably due to the high uncertainty of the predictive density. On the basis of these results we are not able to fi nd a model suitable for all variables; we propose the use of model based on combining forecasts, as evidenced by the results obtained.

This study dealt with economic growth and residential distribution of a small-open economy. The unique contribution of the paper is that the model integrates the Solow growth and Alonso residential distribution models with endogenous land value. The economic system endogenously determines land value and rent with interactions between wealth accumulation, amenity, land, and transportation conditions. We simulated the motion of the spatial economy over time and space. We also carried out comparative dynamic analysis with regard to the rate of interest, the total productivity of the industrial sector, and preference on the spatial dynamics. Although the model is developed with microeconomic foundation and deals with complicated interactions among many variables over time and space, it is based on many strict assumptions. Many limitations of the model become apparent in the light of the sophistication of the literature of economic growth theory, regional science and urban economics.

If this implication seems to clash with experience of small open economies, it is worth noting, however, that in a dynamic, Harrod-Domar, version of such a model, the balance of trade de[r]

Second, the best of our knowledge, there is no study available that has evaluated and analyzed Pakistan economy on the lines of micro-founded new-Keynesian models. Among the available literature on economic modeling for Pakistan economy, nonetheless, one may see four major publications with reference to large macroeconometric modeling: (i) Naqvi et al. (1983) and its revised version Naqvi and Ahmed (1986); (ii) Chishti et al. (1992); (iii) Haque et al. (1994) and (iv) Pasha et al. (1995). In addition to this three studies on Computable General Equilibrium (CGE) modeling: (i) McCathy and Taylor (1980); (ii) Siddiqui and Iqbal (2001); and (iii) Siddiqui and Kemal (2006). The studies explore general equilibrium policy and welfare tradeoffs especially on fiscal side of the Pakistan economy. Furthermore, they remain insufficient in answering several policy oriented questions. Among the many other questions these models absolutely fail to take care of Lucas critique. This study therefore also endeavors to fill this gap in the Pakistan economic literature.

In developing countries with serious poverty, the health-related policies have a large im- pact not only on these countries’ aggregate health degrees but also their whole economies. Hence, in this paper, to give a solution for the above paradox, we construct a dynamic general equilibrium model of a small open economy with a health status variable. As for the health status variable, we assume the following. First, the health degrees of agents are incorporated into their utility, which quantifies a health-related quality of life mentioned in Sen (1981), Torrance (1986), Gordon et al. (1993) and Dolan (2000). In other words, we assume that when the level of health-related quality of life increases, their utility level increases as well. Second, the health status variable, represented by the health-related quality of life, is evolved over time. Concretely, increasing the private investment in health derives a higher level of health-related quality of life and increases the level of utility, but increased labor harms the state of health and decreases the level of utility. Under this set-up, the purpose of this paper is to examine the dynamic impacts of the temporary change in health-related public instru- ments on the health-related quality of life as well as on the domestic economy. The reason why we shed light on the temporary execution is that the government budget of health-related policies will be replaced by other policies during the economic development. This is because as people become richer, the private spending for health increases. Specifically, we introduce two forms of health-related policies: a direct transfer and a subsidy of health investment. Furthermore, to shed light on this finding, we add a direct transfer of health investment in the form of foreign aid. Our main finding is that the temporary enforcement of health-related policies controlled by domestic government does not improve the health-related quality of life; and alternatively, foreign aid improves it in the long run.

be able to adjust for additive disturbances with the result that the implemented u^_ will be sub-optimal. Even if the shocks are extremely small, the model may not be able to adequately forecast the future and the policy-maker will be severely limited in his ability to take account of uncertainty. Whether or not ignorance of future shocks and poor fore­ casts will pose serious problems, especially when fine tuning is desired, depends on the degree of sub-optimality. Even if instantaneous policy adjustment can be carried out there still remains the problem of gaining good information about the immediate past state. It may be necessary to derive the optimal control before the final figures for say income, have been formulated for a particular quarter. Initial estimates can contain "noise" elements which may obscure the "true" value considerably. The problem of uncertainty about the immediate past state whether generated by a need for forward planning or by an inability to correctly observe the

ences in theoretical model and can identify, from an economic point of view, potential or saturation levels (according to the sign of the residue) exchanges. The interpretation of the modeling results is made according to the standard criteria of regression and analysis of variance [8] based on correlation coefficients, significance tests and the va- riance inflation factor values and using graphics and exploratory methods [9]. Exports are firstly employed in domestic production and also foreign demand [10]. We deduce that green coffee production coefficient of Togo in year t is positive and the world cof- fee exports coefficient in year t is negative.

C alibrated to the Brazilian economy, the model successfully reproduces stylized facts of emerging economy business cycles. Credit shocks, either to the benchm ark risk-free interest rate or to the exogenous component of the country spread, can have pronounced and prolonged effects, with the ability to collectively account for 30% to 50% of the macroeconomic variability. These shocks contribute to the excess of consum ption’s variability relative to output. Responses of output, consumption and investment to both kinds of credit shocks share similar hump- or V-shaped dynamics. Shocks to the benchmark international rate propagate further through their transmission via the country spread, while shocks to the country spread display higher standard deviations than those of the benchmark risk-free international rate. These distinctive features of credit shocks afford them equivalent explanatory power when accounting for the variability of macroeconomic aggregates and changes in the country’s interest rate. Similar to other spreads in financial markets (Collin-Dufresne et al., 2001), country spreads display some persistence over realistic business cycle frequencies, which can be due to both endogenous and exogenous factors. Of the domestic variables, short term foreign debt can play a key role in the propagation of credit shocks, since it has the ability to induce country spread changes.

g r θ = g = β α p − r µ r θ + β r (20) The first term of Equation (20) depends on the leverage factor of investments and difference between the marginal investment returns, and the second term corresponds to the return from foreign bubbly assets. Thus, we call these terms “extended invest- ment leverage” and “foreign investment income”, respectively. This second effect is a unique characteristic of a small open economy. If the economy has high financial fric- tion (low θ ) or low internal investment opportunity (low p ), the entrepreneur has a lot of residual assets. Investing the majority of residual assets on foreign bubbly assets, the country is more influenced by the emergence and bursting of foreign asset bubbles. Theorem 1 implies that countries with relatively high financial friction tend to become creditor nations, and their economic growth rates are maintained at a high level before asset bubbles in a large foreign country burst. These implications obtained from this model fit the observed facts. The following Figure 1 and Figure 2 show the economic growth rates and the balance of current account and GDP ratio in several countries be- fore and after the collapse of Lehman Brothers.

Abstract: This paper presents a dynamic small open economy version of the standard neoclassical exogenous growth model with international migration. It considers both the case of perfect world capital markets and the case of imperfect capital markets and shows that local indeterminacy always arises independently of the capital market regime. To study the dynamic implications of migration on domestic consumption, current account and capital accumulation, we simulate the model numerically by distinguishing three di¤erent scenarios depending on whether the initial immigration ratio is larger, equal or smaller than its steady-state value. In the case of perfect world capital markets, we …nd that migration has only a temporary impact on capital accumulation, but a permanent impact on domestic consumption and foreign debt. Instead, in the case of imperfect world capital markets, we …nd that migration has only temporary impacts on all the main macroeconomic variables.

activities the return to N people goes down to zero. And on the other hand whether Z survives or not that crucially depends on how many people are involved in extortion activities or how much is paid for these extortionists. Say α is the fraction of output that is lost due to these political/institutional complications related intermediations. Thus we can coin this sort of intermediations as directly unproductive profit-seeking activities (Bhagwati, 1982). This is the concept of corruption that we are going to use in our model. In an earlier but a different paper Mandal and Marjit (2010) used the similar notion of corruption to explain the wage distribution between skilled and unskilled.