Spurious Welfare Reversals in International Business Cycle Models

Jinill Kim and Sunghyun Kim ()

Virginia Economics Online Papers from University of Virginia, Department of Economics

Abstract: Several papers on international business cycles have documented spurious welfare reversals, in that incomplete market economies can produce higher welfare than the complete market economy. This paper demonstrates how conventional linearization, as used in King, Plosser, and Rebelo (1988), can generate approximation errors that are large enough to result in such reversals. Using a two-country production economy without capital, we argue that spurious welfare reversals are not only possible but also plausible under reasonable parameter values. As a constructive alternative, this paper proposes an approximation method that modifies the conventional linearization method by a bias correction---the linear approximation around a 'stochastic' steady state. We show that this method can be easily implemented to accurately approximate the exact solution and therefore produce the correct welfare ordering. The accuracy of the proposed method is far better than that of the conventional linearization method and as good as that of a method involving a second-order expansion.

Keywords: Linearization; Stochastic steady state; Welfare; Risk sharing (search for similar items in EconPapers)
JEL-codes: E3 F3 F4 (search for similar items in EconPapers)
Pages: 42 pages
Date: 1999-10
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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http://repec.as.virginia.edu/RePEc/vir/virpap/papers/virpap319.pdf (application/pdf)

Related works:
Journal Article: Spurious welfare reversals in international business cycle models (2003)
Working Paper: Spurious Welfare Reversals in International Business Cycle Models (2001)
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Persistent link: https://EconPapers.repec.org/RePEc:vir:virpap:319

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