Medium Frequency Cycles, Global Imbalances, and the Puzzles of Open Economy Macroeconomics.

Abstract

This paper examines the ability of the endogenous growth and medium frequency cycle model of Holden (2016) to explain global imbalances and the puzzles of open economy macroeconomics. The model features complete international financial markets, and intrinsically multi-national R&D, yet is still able to get persistent movements in country-specific variables, including positive correlation between prices and consumption following some shocks. Key to the model’s mechanism is the complementarity between capital (including human capital) and embodied technology, which captures the necessity of investment and training before new technologies may be adopted. The crucial role played by capital in the model’s transmission mechanism gives an important role to financial disturbances and financial frictions, which we model in an original parsimonious form. We also introduce a novel production function that allows for short run non-unitary elasticities of substitution, while being consistent with balanced growth even when factors grow at differing rates.