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

Oliver de Groot, C. Bora Durdu and Enrique Mendoza

No 2020-006, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

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 (search for similar items in EconPapers)
JEL-codes: D82 E44 F41 (search for similar items in EconPapers)
Pages: 75 p.
Date: 2020-01-17
New Economics Papers: this item is included in nep-dge, nep-mac, nep-opm and nep-ore
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Working Paper: Approximately Right?: Global v. Local Methods for Open-Economy Models with Incomplete Markets (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2020-06

DOI: 10.17016/FEDS.2020.006

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