Essays in international finance with a new-keynesian perspective

Abstract

The goal of this research is primarily to analyze the inherent nonlinear and complex dynamics that relates the effect of either the sovereign debt or the spread on the optimal growth prospect of a small open-economy in a new-Keynesian setting. To achieve this, the research first engaged in a modeling experiment to construct an artificial economy that generates endogenous fluctuations exhibiting structural instability. This debunks the dominant neoclassical emphasis on uniqueness and global stability as the standard and only acceptable dynamical properties of macroeconomic growth models. It further challenges the neoclassical conviction on the magic of the invisible hand to unequiv-ocally guide the macroeconomy toward a unique and globally stable equilibrium, which constitutes the basis for the "hands-off" principle. Secondly, it shows how nonlinear dynamical models and the qualitative geometric method of analyzing nonlinear and complex dynamic behavior can improve our understanding of macroeconomic behavior. Discussions initially focus on the neoclassical emphasis on the global properties of uniqueness and saddle-path stability in models where the economic agent is endowed with rational expectations and perfect foresight. In terms of modern dy-namic analysis, neoclassical growth models exhibit structural stability, which does not allow for the existence of a center manifold where short-term fluctuations can have permanent and structural effects on the global behavior of the aggregate economy. The Lyapunov- Poincaré definition of structural stability emphasizes that a slight change in a control or bifurcation parameter does not, in any way, change the geometry of the state-space of a dynamical system. Hence, introducing shocks into the neoclassical growth model will not in any way affect the global property of saddle-path stability. Any fluctuations that arise in the aggregate economy will be due to an external white noise shock, which do not have any permanent or persistent effect on the long-run trajectory of the aggregate economy. Structural stability is not present in Keynesian models in general. This is consistent with Keynes’s view that there exists fundamental uncertainty in the aggregate economy, by which policy (e.g. fiscal or monetary) can have a stabilizing role to play. This view is the basis for the new-Keynesian dynamical model proposed in this study to explain the dynamic nonlinear relationship between sovereign debt and growth. Lastly, in the same vein, following the importance of nonlinear dynamics to analyze macroeconomic relationships, an empirical application is carried out. A dynamic panel threshold model is used to test the existence of a threshold effect in the way how the sovereign spread affects growth in output for both Eurozone and non-Eurozone countries. Results indicate a significant threshold effect above which, there can exist a significant negative effect of the change in the sovereign spread on output (the "confidence fairy"), but only for Eurozone countries.