Why Global and Local Solutions of Open-Economy Models with Incomplete Markets Differ and Why it Matters

Oliver de Groot, C. Bora Durdu and Enrique Mendoza

No 31544, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Global and local methods used to study open-economy incomplete-markets models yield different cyclical moments, impulse responses, spectral densities and precautionary savings. Endowment and RBC model solutions obtained with first-order, higher-order, and risky-steady-state local methods are compared with fixed-point-iteration global solutions. Analytic and numerical results show that the differences are due to the near-unit-root nature of net foreign assets under incomplete markets and inaccuracies of local methods in computing their autocorrelation. In a Sudden Stops model, quasi-linear methods that handle occasionally binding constraints understate the size of credit constraint multipliers, financial premia and macroeconomic responses.

JEL-codes: F41 F44 G01 G15 (search for similar items in EconPapers)
Date: 2023-08
New Economics Papers: this item is included in nep-dge, nep-ifn and nep-opm
Note: IFM
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