A Redux of the Workhorse Noem Model with Capital Accumulation and Incomplete Asset Markets

Posted: 14 Jul 2021

See all articles by Enrique Martínez-García

Enrique Martínez-García

Federal Reserve Bank of Dallas - Research Department

Multiple version iconThere are 2 versions of this paper

Date Written: 2011

Abstract

I build a symmetric two-country model that incorporates nominal rigidities, local-currency pricing and monopolistic competition distorting the goods markets. The model is similar to the framework developed in Martnez-Garca and Sndergaard (2008a, 2008b), but it also introduces frictions in the assets markets by restricting the financial assets available to two uncontingent nominal bonds in zero-net supply and by adding quadratic costs on international borrowing (see, e.g., Benigno and Thoenissen (2008) and Benigno (2009). The technical part of the paper contains three basic calculations. First, I derive the equilibrium conditions of the open economy model under local-currency pricing and incomplete asset markets. Second, I compute the zero-inflation (deterministic) steady state and discuss what happens with a non-zero net foreign asset position. Third, I derive the log-linearization of the equilibrium conditions around the deterministic steady state. The quantitative part of the paper aims to give a broad overview of the role that incomplete international asset markets can play in accounting for the persistence and volatility of the real exchange rate. I find that the simulation of the incomplete and complete asset markets models is almost indistinguishable whenever the business cycle is driven primarily by either nonpersistent monetary or persistent productivity (but not permanent) shocks. In turn, asset market incompleteness has more sizeable wealth effects whenever the cycle is driven by persistent (but not permanent) investment-specific technology shocks, resulting in significantly lower real exchange rate volatility.

Suggested Citation

Martinez-Garcia, Enrique, A Redux of the Workhorse Noem Model with Capital Accumulation and Incomplete Asset Markets (2011). Globalization and Monetary Policy Institute Working Paper No. 74, Available at SSRN: https://ssrn.com/abstract=3885387

Enrique Martinez-Garcia (Contact Author)

Federal Reserve Bank of Dallas - Research Department ( email )

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