Approximately Right?: Global v. Local Methods for Open-Economy Models with Incomplete Markets
Global and local methods are widely used in international macroeconomics to analyze incomplete-markets models. We study solutions for an endowment economy, an RBC model and a Sudden Stops model with an occasionally binding credit constraint. First-order, second-order, risky steady state and DynareOBC solutions are compared v. fixed-point-iteration global solutions in the time and frequency domains. The solutions differ in key respects, including measures of precautionary savings, cyclical moments, impulse response functions, financial premia and macro responses to credit constraints, and periodograms of consumption, foreign assets and net exports. The global method is easy to implement and faster than local methods for the endowment model. Local methods are faster for the RBC model and the global and DynareOBC solutions are of comparable speed. These findings favor global methods except when prevented by the curse of dimensionality and urge caution when using local methods. Of the latter, first-order solutions are preferable because results are very similar to second-order methods.
Previously circulated as "Global v. Local Methods in the Analysis of Open-Economy Models with Incomplete Markets." We thank Tom Holden, Matteo Iacoviello, and Rob Vigfusson for helpful discussions and comments, and Holt Dwyer, Alex Martin and Sergio Villalvazo for excellent research assistance. We are also grateful for comments by conference and seminar participants at the 2017 Dynare Conference, the 2018 SED Meeting, the 2018 North American Meetings of the Econometric Society, the Bank of Finland, George Washington University, and the 2018 Central Bank Macroeconomic Modeling Workshop. The views expressed in this paper are those of the authors and should not be attributed to the Board of Governors of the Federal Reserve System, its staff, or the National Bureau of Economic Research.
Oliver de Groot
Oliver de Groot is a paid consultant to the European Central Bank. The views expressed herein are those of the authors and do not necessarily reflect the views of the ECB.Ceyhun Bora Durdu
The views expressed herein are those of the authors and should not be attributed to the Board of Governors of the Federal Reserve
System or its staff.