Currency substitution as an automatic stabilizer

In the presence of frictions, the existing literature shows that currency substitution is detrimental for domestic aggregate stability. This paper singles out the role of currency substitution and shows that diversified currency holdings operate as an automatic stabilizer that mitigates belief-driven cyclical fluctuations in Farmer’s (1997) indeterminate monetary economy. When the foreign inflation rate is lower than the domestic inflation rate, the model’s steady state always displays saddle-path stability. Hence, equilibrium indeterminacy originally present in the domestic country is entirely removed in the presence of diversified currency holdings. When the foreign inflation rate is higher than the domestic inflation rate, then depending on the degrees of currency substitution and relative risk aversion, indeterminacy is either impossible or the requisite level of the foreign inflation rate for indeterminacy is too high to square with data. The stabilizing effect of diversified currency holdings on domestic aggregate stability is robust to whether domestic and foreign currencies display as Edgeworth substitutes or complements, or are additively separable in the household’s preferences.

EQUILIBRIUM INDETERMINACY, ENDOGENOUS ENTRY AND EXIT, AND INCREASING RETURNS TO SPECIALIZATION

This paper systematically examines the interrelations between equilibrium indeterminacy, endogenous entry and exit of intermediate input firms, and increasing returns to specialization within two versions of a parsimonious one-sector monopolistically competitive RBC model. The technology for producing an intermediate good is postulated to display internal increasing returns to scale in our benchmark framework, whereas positive productive externalities are considered in the alternative setting. We analytically show that either formulation will exhibit belief-driven cyclical fluctuations provided the equilibrium wage-hours locus is positively sloped and steeper than the household’s labor supply curve. We also find that ceteris paribus our alternative macroeconomy is more susceptible to indeterminacy and sunspots than the baseline counterpart.

THE INSTABILITY OF OPEN PARETO EFFICIENT ECONOMIES

This paper analyzes the impact of trade on the stability properties of trading countries and on stationary welfare. We consider a two-country two-good two-factor overlapping generations model where countries differ in terms of their technology. In the autarky equilibrium and the free-trade equilibrium, indeterminacy relies, under dynamic efficiency, on a capital intensive consumption good and intermediate values of the elasticity of intertemporal substitution in consumption. Opening the borders to trade can be a source of a global destabilizing effect. Indeed, considering a free-trade equilibrium in which one country is an exporter of the consumption good and the other country is an exporter of the investment good, indeterminacy can occur with trade even though the two countries are determinate in autarky. Finally, opening to trade increases the stationary welfare of the country that exports the investment good and deteriorates the one of the other country.

Computing sunspot solutions to rational expectations models with timing restrictions

Rational expectations (RE) frameworks featuring informational constraints are becoming increasingly popular in macroeconomic research. A recent strand of literature has explored the analytics of RE models with informational subperiods, in which the occurrence of exogenous shocks is period-specific and decision makers condition their own choices and expectations upon a sequence of nested information sets (timing restrictions). Assuming the unrestricted (full information) RE model satisfies saddle-path stability, this paper provides (i) necessary and sufficient conditions for existence of an uncountably infinite set of linearly perturbed solutions to its restricted (informationally constrained) counterpart, and (ii) an algorithm for computing the full set of sunspot solutions when equilibrium indeterminacy occurs.

EQUILIBRIUM INDETERMINACY IN ONE-SECTOR SMALL OPEN ECONOMIES: THE ROLE OF INTERNATIONAL LABOR MIGRATION

This paper presents a Ramsey-like dynamic small open economy with endogenous labor migration. In the model, the domestic economy is free to borrow or lend as much as it wants at the given world interest rate, and individuals are supposed to be free to move from a country to another in response to the emergence of a wage differential between countries. Our analysis can be ideally split in two parts. Initially, we propose a baseline model in which only natives are allowed to save and invest in capital assets and traded bonds, whereas immigrants are credit constrained. Next, we provide an extension in which all individuals, including immigrants, have full access to international financial markets. We find that the steady state is always local indeterminate, and that the adjustment dynamics of the competitive equilibrium is dependent upon the initial level of the immigration ratio.