Can a small New Keynesian model of the world economy with risk‐pooling match the facts?. (28th July 2020)

• Record Type: Journal Article
• Authors: Minford, Patrick; Ou, Zhirong; Zhu, Zheyi
• Is Part Of: International journal of finance & economics. Volume 26:Number 2(2021)
• Page Start: 1993
• Page End: 2021
• Publication Date: 2020-07-28
• Subjects: Indirect inference -- open economy -- risk‐pooling -- test -- UIP; International finance -- Periodicals; Economics -- Periodicals; 332
• DOI: 10.1002/ijfe.1890
• Languages: English
• ISSNs: 1076-9307

Abstract

Abstract: We ask whether a model of the US and Europe trading with the rest of the world can match the facts of world behaviour in a powerful indirect inference test. One version has uncovered interest parity (UIP), the other risk‐pooling. Both pass the test but the most probable is risk‐pooling. This is consistent with risk‐pooling failing a number of single‐equation tests, as has been found in past work; we show that these tests will typically reject risk‐pooling when it in fact prevails. World economic behaviour under risk‐pooling shows much stronger spillovers than under UIP with opposite monetary responses to the exchange rate. We argue that the risk‐pooling model therefore demands more attention from policy‐makers.