Robustness, information-processing constraints, and the current account in small open economies

Yulei Luo (), Jun Nie and Eric Young

No RWP 10-17, Research Working Paper from Federal Reserve Bank of Kansas City

Abstract: We examine the effects of two types of informational frictions, robustness (RB) and nite information-processing capacity (called rational inattention or RI) on the current account, in an otherwise standard intertemporal current account (ICA) model. We show that the interaction of RB and RI has the potential to improve the model?s predictions on the joint dynamics of the current account and income: (i) the contemporaneous correlation between the current account and income, (ii) the volatility and persistence of the current account in small open emerging and developed economies. In addition, we show that the two informational frictions could also better explain consumption dynamics in small open economies: the impulse responses of consumption to income shocks and the relative volatility of consumption growth to income growth. Calibrated versions using detection probabilities t the data better along these dimensions than the standard model does.

Date: 2010
New Economics Papers: this item is included in nep-dge, nep-mic and nep-opm
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Citations: View citations in EconPapers (10)

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Journal Article: Robustness, information–processing constraints, and the current account in small open economies (2012)
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