International Finance Discussion Papers (IFDP)
August 2006 (Revised March 2011)
Closing Large Open Economy Models
Martin Bodenstein
Abstract:
A large class of international business cycle models admits multiple locally isolated deterministic steady states, if the elasticity of substitution between traded goods is sufficiently low. I explore the conditions under which such multiplicity occurs and characterize the dynamic properties in the neighborhood of each steady state. Models with standard incomplete markets, portfolio costs, a debt-elastic interest rate, or an overlapping generations framework allow for multiple steady states, if the model features multiple steady states under financial autarchy. If the excess demand for the foreign traded good is increasing in the good's own price in a given steady state, the equilibrium dynamics around this steady state are unbounded. Otherwise, the dynamics are bounded and unique. By contrast, with Uzawa-type preferences, the steady state is always unique and the associated equilibrium dynamics are always bounded and unique. The same results obtain under complete markets.
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Keywords: Stationarity, incomplete markets, open economy, multiple equilibria
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