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Size, openness, and macroeconomic interdependence

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  • Alexander Chudik
  • Roland Straub

Abstract

The curse of dimensionality, a problem associated with analyzing the interaction of a relatively large number of endogenous macroeconomic variables, is a prevailing issue in the open economy macro literature. The most common practice to mitigate this problem is to apply the so-called Small Open Economy Framework (SOEF). In this paper, we aim to review under which conditions the SOEF is a justifiable approximation and how severe the consequences of violation of key conditions might be. Thereby, we use a multicountry general equilibrium model as a laboratory. ; First, we derive the conditions that ensure the existence of the equilibrium and study the properties of the equilibrium using large N asymptotics. Second, we show that the SOEF is a valid approximation only for economies (i) that have a diversified foreign trade structure and if (ii) there is no globally dominant economy in the system. Third, we illustrate that macroeconomic interdependence is primarily related to the degree of trade diversification, and not to the extent of trade openness. Furthermore, we provide some evidence on the pattern of global macroeconomic interdependence by calculating probability impulse response functions in our calibrated multicountry model using data for 153 economies.

Suggested Citation

  • Alexander Chudik & Roland Straub, 2011. "Size, openness, and macroeconomic interdependence," Globalization Institute Working Papers 103, Federal Reserve Bank of Dallas.
  • Handle: RePEc:fip:feddgw:103
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    References listed on IDEAS

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    3. Michaelides, Panayotis G. & Tsionas, Efthymios G. & Konstantakis, Konstantinos N., 2018. "Debt Crisis in Europe (2001-2015): A Network General Equilibrium GVAR approach," MPRA Paper 89998, University Library of Munich, Germany.
    4. Konstantakis, Konstantinos N. & Michaelides, Panayotis G. & Tsionas, Efthymios G. & Minou, Chrysanthi, 2015. "System estimation of GVAR with two dominants and network theory: Evidence for BRICs," Economic Modelling, Elsevier, vol. 51(C), pages 604-616.
    5. Zhang, Wen, 2022. "China’s government spending and global inflation dynamics: The role of the oil price channel," Energy Economics, Elsevier, vol. 110(C).
    6. Montinari, Letizia & Stracca, Livio, 2016. "Trade, finance or policies: What drives the cross-border spill-over of business cycles?," Journal of Macroeconomics, Elsevier, vol. 49(C), pages 131-148.
    7. Tsionas, Efthymios G. & Konstantakis, Konstantinos N. & Michaelides, Panayotis G., 2016. "Bayesian GVAR with k-endogenous dominants & input–output weights: Financial and trade channels in crisis transmission for BRICs," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 42(C), pages 1-26.
    8. Razafindrabe, Tovonony M., 2016. "A multi-country DSGE model with incomplete exchange rate pass-through: An application for the Euro-area," Economic Modelling, Elsevier, vol. 52(PA), pages 78-100.
    9. Alexander Chudik, 2014. "Toward a Better Understanding of Macroeconomic Interdependence," Annual Report, Globalization and Monetary Policy Institute, Federal Reserve Bank of Dallas, pages 16-21.
    10. Georgescu Vladimir, 2014. "Patterns in Trade in Selected European Union Countries," Ovidius University Annals, Economic Sciences Series, Ovidius University of Constantza, Faculty of Economic Sciences, vol. 0(1), pages 125-130, May.
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    12. Alexander Chudik & Vanessa Smith, 2013. "The GVAR approach and the dominance of the U.S. economy," Globalization Institute Working Papers 136, Federal Reserve Bank of Dallas.

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    More about this item

    Keywords

    International trade;

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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