Approximately Right?: Global v. Local Methods for Open-Economy Models with Incomplete Markets

75 Pages Posted: 14 May 2020

See all articles by Oliver de Groot

Oliver de Groot

University of Liverpool Management School

Ceyhun Bora Durdu

Board of Governors of the Federal Reserve System

Enrique G. Mendoza

National Bureau of Economic Research (NBER); University of Pennsylvania

Date Written: January 17, 2020

Abstract

Global and local methods are widely used in international macroeconomics to analyze incomplete-markets models. We study solutions for an endowment economy, an RBC model and a Sudden Stops model with an occasionally binding credit constraint. First-order, second-order, risky steady state and DynareOBC solutions are compared v. fixed-point-iteration global solutions in the time and frequency domains. The solutions differ in key respects, including measures of precautionary savings, cyclical moments, impulse response functions, financial premia and macro responses to credit constraints, and periodograms of consumption, foreign assets and net exports. The global method is easy to implement and faster than local methods for the endowment model. Local methods are faster for the RBC model and the global and DynareOBC solutions are of comparable speed. These findings favor global methods except when prevented by the curse of dimensionality and urge caution when using local methods. Of the latter, first-order solutions are preferable because results are very similar to second-order methods.

Keywords: Solution methods; Sudden stops; Incomplete markets; Precautionary savings; Occasionally binding constraints

JEL Classification: D82; E44; F41

Suggested Citation

de Groot, Oliver and Durdu, Ceyhun Bora and Mendoza, Enrique G., Approximately Right?: Global v. Local Methods for Open-Economy Models with Incomplete Markets (January 17, 2020). FEDS Working Paper No. 2020-006 https://doi.org/10.17016/FEDS.2020.006 , Available at SSRN: https://ssrn.com/abstract=3600397

Oliver De Groot (Contact Author)

University of Liverpool Management School ( email )

Ceyhun Bora Durdu

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Enrique G. Mendoza

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of Pennsylvania ( email )

Philadelphia, PA 19104
United States

HOME PAGE: http://www.sas.upenn.edu/~egme/index.html

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