Since the launch of the euro, the Euro Area has combined weak growth with persistent trade surpluses, a rising trade share, and the absence of a real exchange rate trend. In academic and policy debates, the Euro Area's trade surplus is often viewed as reflecting weak domestic aggregate demand. This paper argues that a purely demand-based view of the trade balance is incomplete. Using an estimated two-region framework, we find that slower productivity growth in the Euro Area has been a major driver of the trade surplus since 1999, while demand shocks play an important role in the rising trade balance following the global financial crisis. We further show that real exchange rate dynamics cannot be understood from productivity growth differentials and aggregate demand shocks alone, but also reflect longer-run shifts in trade patterns.

This paper constructs speculative bubbles in a Real Business Cycle (RBC) economy. Building on Blanchard’s (Economics Letters, 1979) classic analysis of speculative bubbles in asset pricing models, the bubbles studied here result from the absence of a transversality condition for production capital. It is shown that speculative bubbles can generate boom-bust cycles of investment and output that are bounded, persistent and recurrent. Importantly, speculative bubbles can arise when there are no shocks to technologies or preferences; speculative bubbles are thus a novel potential source of real activity fluctuations.

We develop a New Keynesian (NK) model with endogenous price setting frequency. Whether a firm updates its price is a discrete choice: when expected benefits outweigh expected costs, prices are reset optimally. The model gives rise to a non-linear Phillips curve as prices are more flexible during demand-driven expansions and less so during demand-driven recessions. Monetary policy can have substantial real effects despite the model having a state-dependent pricing component. Our quantitative analysis shows that contrary to the standard NK model, the assumed price setting behavior: (i) is consistent with micro data on price setting frequency; (ii) generates a direct effect of the time-varying price setting frequency on inflation; (iii) creates time-variation in the Phillips curve slope that explains shifts in the Phillips curve associated with different historical episodes; (iv) explains inflation dynamics without relying on implausible high cost-push shocks and nominal rigidities inconsistent with micro data; (v) reconciles the NK model with observed inflation moments.

This paper develops a novel tractable overlapping generations (OLG) structure whose aggregate equations resemble a model of an infinitely lived representative agent, except that there are no aggregate transversality conditions in the OLG economy. The main assumptions are complete markets and time-invariant (but age-dependent) consumption shares of age-groups. The tractability of the OLG structure here distinguishes it from conventional OLG models - the present structure is suitable for quantitative dynamic stochastic general equilibrium (DSGE) macro models. Importantly, the OLG structure here maintains key predictions of standard OLG models, namely the possibility of low real interest rates and of equilibrium indeterminacy.(c) 2022 Elsevier B.V. All rights reserved.

Does household heterogeneity matter for exchange rate determination? This paper tests Kocherlakota and Pistaferri’s (2007) prominent heterogeneous agent model, in which the real exchange rate perfectly tracks relative domestic/foreign moments of cross-household consumption distributions. The evidence presented here indicates that the real exchange rate is disconnected from relative cross-household consumption moments.

Frequently, factors other than structural developments in technology and production efficiency drive changes in labor productivity in advanced economies (AEs) and emerging market and developing economies (EMDEs). In this paper, we contrast the responses of AEs and EMDEs to innovations in technology and investigate whether the cross-country co-movement in productivity is due to technological or non-technological factors. We find that technological innovations are associated with higher and more rapidly increasing rates of investment in EMDEs relative to AEs, suggesting that positive technological developments are often capital-embodied in the former economies. Employment falls in both AEs and EMDEs following positive technology developments, with the effect smaller but more persistent in EMDEs. Low cross-country correlations of technological developments suggest that global synchronization of labor productivity growth is primarily due to non-technological influences. Overall, non-technological factors accounted for most of the fall in labor productivity growth during 2007-09 but less than one-half of the longer-term productivity decline after the global financial crisis in the median AE and EMDE.

This paper studies a New Keynesian model of a two-country world with a zero lower bound (ZLB) constraint for nominal interest rates. A floating exchange rate regime is assumed. The presence of the ZLB generates multiple equilibria. The two countries can experience recurrent liquidity traps induced by the self-fulfilling expectation that future inflation will be low. These "expectations-driven" liquidity traps can be synchronized or unsynchronized across countries. In an expectations-driven liquidity trap, the domestic and international transmission of persistent shocks to productivity and government purchases differs markedly from shock transmission in a "fundamentals-driven" liquidity trap.

Does household heterogeneity matter for exchange rate determination? This paper tests Kocherlakota and Pistaferri’s (2007) prominent heterogeneous agent model, in which the real exchange rate perfectly tracks relative domestic/foreign moments of cross-household consumption distributions. The evidence presented here indicates that the real exchange rate is disconnected from relative cross-household consumption moments.

The closed economy macro literature has shown that a liquidity trap can result from the self-fulfilling expectation that future inflation and output will be low. This paper investigates expectations-driven liquidity traps in a two-country New Keynesian model of a monetary union. In the model here, a rise in government purchases in an individual country has a weak effect on GDP in the rest of the union. The results here cast doubt on the view that, in the current era of ultra-low interest rates, a rise in fiscal spending by Euro Area (EA) core countries would significantly boost GDP in the EA periphery.

The closed economy macro literature has shown that a liquidity trap can result from the self-fulfilling expectation that future inflation and output will be low (Benhabib et al. (2001)). This paper investigates expectations-driven liquidity traps in a two-country New Keynesian model of a monetary union. In the model here, country-specific productivity shocks induce synchronized responses of domestic and foreign output, while country-specific aggregate demand shocks trigger asymmetric domestic and foreign responses. A rise in government purchases in an individual country lowers GDP in the rest of the union. The results here cast doubt on the view that, in the current era of ultra-low interest rates, a rise in fiscal spending by Euro Area (EA) core countries would significantly boost GDP in the EA periphery (e.g., Blanchard et al. (2016)). JEL codes: E3, E4, F2, F3, F4.

This paper studies rational bubbles in non-linear dynamic general equilibrium models of the macroeconomy. The term ‘Rational bubble’ refers to multiple equilibria due to the absence of a transversality condition (TVC) for capital. The lack of TVC can be due to an OLG population structure. If a TVC is imposed, the macro models considered here have a unique solution. Bubbles reflect self-fulfilling fluctuations in agents’ expectations about future investment. In contrast to explosive rational bubbles in linearized models (Blanchard (1979)), the rational bubbles in non-linear models here are bounded. Bounded rational bubbles provide a novel perspective on the drivers and mechanisms of business cycles. I construct bubbles (in non-linear models) that feature recurrent boombust cycles characterized by persistent investment and output expansions which are followed by abrupt contractions in real activity. Both closed and open economies are analyzed. In a non-linear two-country model with integrated financial markets, bubbles must be perfectly correlated across countries. Global bubbles may, thus, help to explain the synchronization of international business cycles.

This paper studies fluctuations of interest rates, inflation and output in a two-country New Keynesian business cycle model with a zero lower bound (ZLB) constraint for nominal interest rates. The presence of the ZLB generates multiple equilibria driven by self-fulfilling changes in domestic and foreign inflation expectation. Each country randomly switches in and out of a liquidity trap. In a floating exchange rate regime, liquidity traps can either be synchronized or unsynchronized across countries. This is the case even if countries are perfectly financially integrated. By contrast, in a monetary union, self-fulfilling fluctuations in inflation expectations must be perfectly correlated across countries.

International financial integration has faced major changes and challenges since the 2008-09 global financial crisis. The crisis triggered a persistent contraction in international capital flows. Regulatory reforms and new macro-prudential frameworks have been reshaping international finance since the crisis. Financial flows are also affected by the unwinding of ultra-accommodative post-crisis monetary policies in advanced economies. Finally, protectionist attitudes have been on the rise, since the financial crisis, and already shape the agenda of a number of governments in advanced economies. This special issue of the Journal of International Money and Finance consists of thirteen papers that provide new perspectives on key issues facing international financial integration. All papers were presented at a conference held at the European Commission in Brussels on March 1-2, 2018, organized by the Journal of International Money and Finance, the European Commission, CEPR, Tilburg University, Universite Libre de Bruxelles, University of British Columbia, University of Southern California, and University of Wisconsin.

The trade balances of the Euro Area (EA) and of the U.S. have improved markedly after the Global Financial Crisis.This paper quantifies the drivers of EA and U.S. economic fluctuations and external adjustment, using an estimated (1999-2017) three-region (U.S., EA, rest of world) DSGE model with trade in manufactured goods and in commodities.In the model, commodity prices reflect global demand and supply conditions.The paper highlights the key contribution of the post-crisis collapse in commodity prices for the EA and U.S. trade balance reversal.Aggregate demand shocks originating in Emerging Markets too had a significant impact on EA and U.S. trade balances.The broader lesson of this paper is that Emerging Markets and commodity shocks are major drivers of advanced countries' trade balances and terms of trade.

The business cycles of advanced economies are synchronized. Standard macro models fail to explain that fact. This paper presents a simple model of a two-country, two-traded-good, complete-financial-markets world in which country-specific productivity shocks generate business cycles that are highly correlated internationally. The model assumes recursive intertemporal preferences (Epstein-Zin-Weil), and a muted response of labor hours to household wealth changes (due to Greenwood-Hercowitz-Huffman period utility and demand-determined employment under rigid wages). Recursive intertemporal preferences magnify the terms of trade response to country-specific shocks. Hence, a productivity (and GDP) increase in a given country triggers a strong improvement of the foreign country’s terms of trade, which raises foreign labor demand. With a muted labor wealth effect, foreign labor and GDP rise, i.e. domestic and foreign real activity comove positively.

This note corrects Blanchard and Kahn’s (1980) solution for a linear dynamic rational expectations model with one state variable and one control variable.

The Global Crisis led to a sharp contraction and long-lasting slump in both Eurozone and US real activity, but the post-crisis adjustment in the Eurozone and the US shows striking differences. This column argues that financial shocks were key determinants of the 2008-09 Great Recession, for both the Eurozone and the US. The post-2009 slump in the Eurozone mainly reflects a combination of adverse aggregate demand and supply shocks, in particular lower productivity growth, and persistent adverse shocks to capital investment linked to the poor health of the Eurozone financial system. Mono-causal explanations of the persistent slump are thus insufficient. Adverse financial shocks were less persistent for the US.

This paper presents a simple and fast maximum likelihood estimation method for non-linear DSGE models that are solved using a second- (or higher-) order accurate approximation. The method requires that the number of observables equals the number of exogenous shocks. Exogenous innovations are extracted recursively by inverting the observation equation, which allows easy computation of the likelihood function.

Tax-deferred saving accounts (TDA) are systematically used in many countries. In the United States, households' access to TDA exhibits substantial heterogeneity: 401(k) has a higher contribution limit than IRA, but only 50% of workers are eligibility for it. I developed an overlapping-generations model that captures the tax benefits of TDA and the heterogeneity in 401(k) eligibility to investigate the quantitative impacts of TDA on the aggregate economy and their implications on policy reforms. Experiment results show that IRA already provides sufficient tax benefits for most households. The effects of providing universal 401(k) are relatively insignificant because households who can benefit from 401(k) already have access to it. On the other hand, raising the TDA contribution limit allows high-income households to increase their use of TDA and results in stronger effects on the economy. When households' use of TDA is considered, the U.S. income tax system is less distortionary and the welfare gain from a consumption tax reform is reduced by more than half.

1. Overview To raise employment and output growth in Europe, the leading multilateral economic institutions (EU Commission, IMF, OECD) routinely recommend ‘structural reforms’ of product and labor markets that increase competition and employment flexibility. Existing model-based analyses of those reforms generally use standard New Keynesian dynamic stochastic general equilibrium (DSGE) models in which pro-competition reforms are represented as exogenous reductions in