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Can a small New Keynesian model of the world economy with risk-pooling match the facts?

A. Patrick Minford, Zhirong Ou () and Zheyi Zhu ()
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Zheyi Zhu: Cardiff Business School

No E2019/10, Cardiff Economics Working Papers from Cardiff University, Cardiff Business School, Economics Section

Abstract: We ask whether a model of the US and Europe trading with the rest of the world can match the facts of world behaviour in a powerful indirect inference test. One version has uncovered interest parity (UIP), the other risk-pooling. Both pass the test but the most probable is risk-pooling. This is consistent with risk-pooling failing a number of single equation tests, as has been found in past work; we show that these tests will typically reject risk-pooling when it in fact prevails. World economic behaviour under risk-pooling shows much stronger spillovers than under UIP with opposite monetary responses to the exchange rate. We argue that the risk-pooling model therefore demands more attention from policy-makers.

Keywords: Opene conomy; UIP; risk-pooling; test; Indirect Inference (search for similar items in EconPapers)
JEL-codes: C12 E12 F41 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2019-04
New Economics Papers: this item is included in nep-dge, nep-mac, nep-opm and nep-ore
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