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Topics Intmacro 1
Topics Intmacro 1
Topics Intmacro 1
Luca Fornaro
Fall 2021
1
Aim of the course
• Capital flows
2
Outline
3
Practical information
Contact: lfornaro@crei.cat, twitter: @lucafornaro3
Office hours: by appointment.
Reading list: see syllabus.
Evaluation: The evaluation is based on a term paper (80%) and
class participation (20%). The term paper consists in extending
in some interesting direction the model of one of the papers listed
at the end of the syllabus. For example, you could modify some
assumption to think about different scenarios, consider alterna-
tive policy interventions, provide a quantitative analysis or rein-
terpret some historical event. You can work on the term paper
in pairs, unless you plan to use the material of the term paper
as basis for your master thesis. Topics for the term paper need
to be discussed with the instructor before XXX. The final paper
will have to be handed before XXX.
4
Capital flows and the business cycle
5
Motivation
6
Capital account openness index
• Research questions
• How do capital flows correlate with the business cycle?
• Can capital flows be a source of economic fluctuations?
• Shall governments regulate capital flows?
8
Spain - Net exports/GDP
-5 NX/GDP
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Source: OECD
9
Spain - GDP per capita
-3.6
-3.7
-3.8
-3.9
-4
-4.1
-4.2
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Source: OECD
10
Spain - detrended GDP & Net exports/GDP
-5
-10
detrended GDP per capita
NX/GDP
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Correlation = -0.8
11
Business cycle facts (Schmitt-Grohé and Uribe, 2015)
Log-quadratic detrending
yt = a + bt + ct 2 + t
ytc = t
yts = a + bt + ct 2
12
Volatility of selected variables
14
Correlations with GDP: small emerging economies
15
Summing up
16
Intertemporal approach to the current account
17
A small open endowment economy
18
Households
Maximize lifetime utility
∞
X
β t u (ct )
t=0
Subject to
bt+1 + ct = yt + bt (1 + r )
bt+j
lim ≥0
j →∞ (1 + r )j
19
Optimality conditions
1) Euler equation
20
Solution
bt+1 + ct = yt + bt (1 + r )
Iterate forward
∞
X ct − yt
b0 (1 + r ) =
t=0
(1 + r )t
Difference between present value of consumption and present
value of income depends on initial bond position
21
Some accounting
Trade balance
TBt = yt − ct
Net foreign assets (start of period)
NFAt = bt
Current account
∞
X c̄ − yt
b0 (1 + r ) =
t=0
(1 + r )t
∞
r X yt
c̄ = + rb0
1 + r t=0 (1 + r )t
23
Optimal consumption and trade balance
TBt = yt − c̄
Trade balance improves in good times and deteriorates in bad
times
CAt = yt − c̄ + rbt
Foreign assets increase in good times and decrease in bad times
24
Constant output yt = ȳ
c̄ = ȳ + rb0
economy rolls over its foreign asset position (bt = b0 for all t)
25
Unanticipated temporary negative output shock
Suppose b0 = 0 and
yL
if t < T
yt =
ȳ if t ≥ T
bt+1 = ȳ − c̄ + (1 + r )bt if t ≥ T
P∞
Recall that since b0 = 0 then t=0 TBt /(1 + r )t = 0
Hence the country runs a trade balance deficit when output is
low and a trade balance surplus when output is high (consistent
with empirical evidence?)
26
Unanticipated temporary negative output shock
27
A stochastic economy
Subject to
bt+1 + ct = yt + bt (1 + r )
bt+j
Et lim ≥0
j →∞ (1 + r )j
28
Technical digression: inducing stationarity
Euler equation
29
How to deal with this?
Mt ≡ β t (1 + r )t u 0 (ct )
Using Euler equation
Mt = Et Mt+1
30
Case β(1 + r ) > 1: implies that for Mt to converge to a finite
value, u 0 (ct ) →a.s. 0 which implies ct →a.s. ∞
Case β(1 + r ) = 1: because of randomness, it is not possible for
Mt to converge to a finite positive value. Hence, Mt will
converge to zero and ct to infinity
Case β(1 + r ) < 1: ct can remain finite and continues to vary
randomly, while M converges to zero because
limt→∞ (β(1 + r ))t = 0
→ β(1 + r ) < 1 is a necessary condition for stationarity
Hence, one possibility is to assume β(1 + r ) < 1, solve the
model using global solution methods and derive a stochastic
steady state
31
Alternative approaches
32
Endogenous discount factor
We consider an external discount factor, which depends on
aggregate variables
∞
X
Et θt u(ct )
t=0
θt+1 = f (ct )θt where fc < 0
Euler equation is now
f (c)(1 + r ) = 1
r (bt ) = r + g(Bt )
34
Back to the model
35
The dynamic programming problem
Subject to
b 0 + c = y + b(1 + r )
b 0 ≥ −κ, c ≥ 0
κ is an ad-hoc borrowing limit
36
Solution method
37
Functional forms
c 1−σ − 1
u(c) =
1−σ
yt evolves according to
log(yt ) = ρ log(yt−1 ) + t
where t ∼ N (0, σ )
38
Parameters
Value Source/Target
Risk aversion σ=2 Standard value
Interest rate r = 4% Standard value
Discount factor β = 0.96 avg. NFA/GDP ≈ −40%
Borrowing limit κ = 1.5 max debt/output = 150%
Standard deviation y σy = 0.063 Estimate for Spain
Persistence y ρ = 0.87 Estimate for Spain
39
Policy function - bonds
-1
avg. output
low output
-1.1
-1.2
-1.3
-1.4
-1.5
-1.5 -1.4 -1.3 -1.2 -1.1 -1
40
Stationary bond distribution
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0 2 4 6
41
Policy function - trade balance
0.08
0.06
0.04
0.02
avg. output
-0.02
low output
42
Simulated data
15
10
% dev. from mean
-5
-10 Y
C
-15
1 1.0002 1.0004 1.0006 1.0008 1.001
105
43
Spain - GDP and absorption
Y
10 C
-5
-10
-15
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
44
Spain - tradable output and absorption
30 Y
C
20
10
-10
-20
-30
-40
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
45
Business cycle statistics
Data Model
Standard deviation y 0.063 0.063
Standard deviation c 0.086 0.067
Standard deviation tb/y 0.026 0.062
Correlation y, tb/y -0.799 0.405
Standard deviation yT 0.087 0.063
Standard deviation cT 0.204 0.067
46
Lessons from endowment economy
47
Capital flows and investment
48
Investment and the current account
49
Model with capital and perfect foresight
∞
X
β t u(ct )
t=0
bt+1 + ct + it = yt + bt (1 + r )
yt = At F (kt )
kt+1 = (1 − δ)kt + it
Optimality conditions
50
Assume β(1 + r ) = 1 we have ct = c̄ and
1 + r = 1 − δ + At+1 F 0 (kt+1 )
∞
r X At+j F (kt+j ) − kt+j +1 + (1 − δ)kt+j
ct = rbt−1 +
1+r (1 + r )j
j =0
51
Current account
CAt ≡ bt+1 − bt
Use resource constraint
CAt = rbt + yt − ct − it
St ≡ rbt + yt − ct
52
Unanticipated permanent increase in TFP
c̄ = rb0 + ȳ
¯ = −rb0
TB
¯ =0
CA
The economy experiences an unanticipated permanent increase
in TFP (↑ A)
53
Unanticipated permanent increase in TFP (δ = 0)
54
Unanticipated permanent increase in TFP
55
Temporary increase in TFP (δ = 0)
56
Temporary increase in TFP
57
Capital adjustment costs
it2
At F (kt ) + (1 + r )bt = bt+1 + ct + it +
2kt
58
∞
1 it2
X
t
L= β U (ct ) + λt At F (kt ) + (1 + r )bt − bt+1 − ct − it − +
t=0
2 kt
1 it+1 2
1
0
qt = At+1 F (kt+1 ) + + qt+1
1+r | {z } 2 kt+1 |{z}
dividends | {z } resale price
future adj. costs
60
Dynamics of the capital stock
kt+1 = qt kt
1 = qt (KK’)
61
Dynamics of the capital stock
62
Capital adjustment costs and capital flows
63