Abstract
This paper propose a two-country, dynamic, stochastic, general equilibrium (DSGE) model with endogenous tradability, product differentiation, variously determined physical capital, and an elastic labor supply to explore the propagation of business cycles across countries. The model successfully addresses international relative price dynamics (its appreciation with positive home productivity shock, called the ‘Harrod-Balassa-Samuelson Effect’) through the entry of producers and their cut-off productivities of exporting. The use of endogenous physical capital in the model induces a more realistic framework since the simulated model is compared to the U.S. investment data that covers spending on capital equipment, structures and inventories for producers’ entry and exit dynamics. Building the model with endogenous capital and elastic labor supply weakens the volatility of investment compared to conventional international real business cycle (IRBC) models. The model also accounts for several features of the data, such as the volatility of aggregate variables and their correlations with GDP.
Highlights
Conventional international real business cycle models (IRBC) fail to account for the appreciation of the international relative prices after an aggregate positive productivity shock in the domestic economy
This paper propose a two-country, dynamic, stochastic, general equilibrium (DSGE) model with endogenous tradability, product differentiation, variously determined physical capital, and an elastic labor supply to explore the propagation of business cycles across countries
Note: These variables are the exporting cut-off productivity of home firms (ZX) and foreign firms (ZXs), the new entrants (NE), the number of foreign exporters (NXs), the terms of efficiency (TOE), the foreign exporting profits, the relative exporting cut-off productivity (ZXZXS), the terms of trade (TOT), and relative consumption
Summary
Conventional international real business cycle models (IRBC) fail to account for the appreciation of the international relative prices (e.g. the real exchange rate or the terms of trade) after an aggregate positive productivity shock in the domestic economy. In standard IRBC models, as in Backus, Kehoe & Kydland (1992, 1994), the relative price of domestically produced goods decreases when domestic GDP increases in response to a positive productivity shock. The volatility of entry is much smaller compared to the no-capital, fixed labor economy of Ghironi & Melitz (2005) This is due to asset market friction in which each country attempts to create more balanced trade since home agents purchase and sell foreign bonds and run a trade deficit or surplus.
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