Productivity Shocks, Learning, and Open Economy Dynamics

Abstract

This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. I study the implications of productivity shocks in a model where agents observe the aggregate level of productivity but not its permanent and transitory components separately. The model's predictions under learning differ substantially from those under full information and are in line with several empirical findings: (i) the response of investment to a permanent shock is sluggish and peaks with delay; (ii) permanent shocks generate positive rather than negative savings on impact; and (iii) saving and investment are highly correlated despite the assumption of capital mobility. Unlike other standard explanations of the Feldstein-Horioka puzzle, learning induces high correlations irrespective of the assumed persistence of shocks.

What Do Productivity Shocks Tell Us About the Saving-Investment Relationship?

“…Interestingly though, while the coeffi cient of Cluster 1 with low expected value of the shocks is found to be small, those of Clusters 2 and 3 with high expected values are large. This fi nding indicates that the coeffi cient gets larger for the countries subject to large productivity shocks, a result that is in line with the simulation studies by Mendoza (1997) and Miniane (2004). This implies that it is the magnitude rather than the variability of shocks that matters.…”

“…Thus, they do not predict that saving responds to a permanent but not persistent shock. However, Miniane (2004) has demonstrated that a permanent shock that is not persistent can also generate a positive saving reaction thanks to the learning process. A learning agent might view part of the permanent shock as temporary due to imperfect information and hence initial response of saving to a permanent shock might be positive.…”

“…This has stimulated a growing interest in the literature on the degree of international capital mobility. One strand of studies has put forward productivity shocks as well as country size to explain how a high correlation between S-I can be compatible in a world with highly integrated international capital markets (Obstfeld, 1986;Mendoza, 1991Mendoza, , 1997Baxter and Crucini, 1993;Glick and Rogoff, 1995;Gregory and Head, 1999;Miniane, 2004).…”

A fuzzy analysis of country-size argument for the Feldstein–Horioka puzzle

“…Firstly, Cardia [9] demonstrated that the failure of real interest rate equalization can lead to a high association between S-I. Secondly, the studies [21,4,19] showed that exogenous disturbances, such as productivity or technology shocks, might result in a co-movement of S-I. For instance, with positive productivity shocks, households get wealthier which give rise to both higher consumption and saving under the assumption that consumption has a smoothing behavior.…”

The Perils of Tax Smoothing: Sustainable Fiscal Policy with Random Shocks to Permanent Output

“…Rather, the government knows only the relative variances of the two shocks. It thus faces a "signal extraction" problem similar to one originally proposed by Muth (1960) (see also Harvey, 1989, andMiniane, 2004).…”