Open economy extensions of real business cycle models, even if generally successful, have met some difficulties replicating a few important stylized facts. In particular these models tend to predict excessive consumption smoothing and consumption correlation across countries. The observed negative correlation between the trade balance and output in developing countries, the variability of the trade balance and its correlation with the terms of trade have also proven difficult to reproduce. The paper considers how introduction of incomplete markets in the form of liquidity constraints can alleviate these problems. This analysis suggests that adding liquidity constraints helps predict the variability of consumption relative to output. It also improves our estimate of the correlation between the trade balance and output. The model correctly replicates the small positive correlation between the terms of trade and the trade balance. However, it slightly underpredicts the variability of the trade balance when fifty percent of the consumers are assumed to be liquidity constrained. (Copyright: Elsevier)
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.
Volume (Year): 2 (1999) Issue (Month): 2 (April) Pages: 370-402 Download reference. The following formats are available: HTML
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Find related papers by JEL classification: E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
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