International Finance Econ-641


Fall 2005, Wednesday 9.00-11.30, ICC 550


Jonathan Heathcote

202 687 5582

ICC 553


This course is not designed to be a comprehensive survey of international macroeconomics. Rather I want to cover a limited number of papers that address what I think are important open questions in the field. We will also cover some useful numerical methods.


The open questions can be divided into three broad areas:


  1. Cross-country differences in living standards and international mobility of factors and technologies.


How do we account for huge cross-country differences in GDP per capita? What would happen if capital and / or labor were allowed to move freely across countries? To what extent is foreign direct investment a way to import higher foreign productivity? How should tax rates on factors of production be set when these factors are internationally mobile?


  1. How much country-specific risk is pooled internationally?


How much information about the extent of international risk-sharing is contained in asset prices or the cross-country correlation structure of macro-aggregates? Why is there so little international diversification in asset holdings? How can we build models that endogenize the extent of international risk-sharing? How do policy choices / exchange rate regimes affect the degree of international risk-sharing?


  1. Why are exchange rates so volatile and so persistent?


Can sticky prices help account for these dynamics? Are the dynamics of international relative prices best explained in terms of real frictions – e.g. shipping costs, distribution costs, search frictions – or is there a role for nominal frictions – sticky prices, internationally incomplete asset markets?



Books and Articles


The most important source for the class will be “Recursive Macroeconomic Theory” 2nd Edition by Ljungqvist and Sargent (LS), MIT Press 2004. You have probably seen some of the material in this book before.


Other useful books are Marimon and Scott eds. Computational Methods for the Study of Dynamic Economics, Oxford University Press 1999, Cooley ed. Frontiers of Business Cycle Research, Princeton University Press 1995, Stokey and Lucas Recursive Methods In Economic Dynamics, Harvard University Press 1989, and Farmer, The Macroeconomics of Self-Fulfilling Prophecies, MIT Press 1993.


Weekly readings and homeworks will be posted on the class webpage, along with supplementary notes / slides / computer codes for the some of the articles.




Homeworks (60%): I will hand out a series of homeworks. Most of these homeworks will have a numerical (computer) component.  I expect you to complete and turn in each homework by the announced date. 


Exam (40%): There will be an exam at a to-be-determined date.


In addition, you should attend the Macro Seminar on Fridays.


Office Hours


Email me to set up an appointment.





Local Approximation Methods


Farmer’s 1993 book

Soderlind 1999: Solution and Estimation of RE Macro-models with Optimal Policy, EER 43

Klein 2000: Using the Generalized Schur Form to Solve a Multivariate Linear Rational Expectations Model, JEDC 24/10

Schmitt-Grohe and Uribe 2004: Solving dynamic general equilibrium models using a second-order approximation to the policy function, JEDC 28


International Mobility of Factors and Technologies


Lucas 1990: Why Doesn’t Capital Flow from Rich to Poor Countries?, AER 80/2.

Klein and Ventura 2005: Do Migration Restrictions Matter?, mimeo University of Western Ontario

Burstein and Monge-Naranjo 2005: Aggregate Consequences of Foreign Firms in Developing Economies, mimeo UCLA

Mendoza and Tesar 2005: Why hasn’t tax competition triggered a race to the bottom? Some quantitative lessons from the EU, JME

McGrattan 2005: Comment on the above paper, JME forthcoming

Quadrini 2004 : Policy commitment and the welfare gains from capital market liberalization, EER forthcoming


Cross-Country Risk Sharing


Business cycle models:

Stock and Watson 2005: Understanding changes in international business cycle dynamics, JEEA

Backus, Kehoe and Kydland chapter in Cooley 1995 book

Baxter and Crucini 1995: Business cycles and the asset structure of foreign trade, IER 36

Heathcote and Perri 2002: Financial Autarky and International Real Business Cycles, JME 49

Heathcote and Perri 2004: Financial Globalization and Real Regionalization, JET



Cole and Obstfeld 1991: Commodity trade and international risk sharing: How much do financial markets matter?, JME 28

Heathcote and Perri 2004: The International Diversification Puzzle is Not as Bad as you Think, mimeo Georgetown


Endogenous borrowing constraints:

Ljungqvist and Sargent 2004 Chapters 19 and 20

Kocherlakota 1996: Implications of Efficient Risk Sharing without Commitment, REStud 63/4

Alvarez and Jermann 2000 : Efficiency, Equilibrium and Asset Pricing with Risk of Default, Econometrica 68/4

Kehoe and Perri 2002 : International Business Cycles with Endogenous Market Incompleteness, Econometrica 70/3, also NBER Working Paper 7870

Arellano and Heathcote 2005: Rules, Discretion and International Risk-Sharing without Enforcement, mimeo Georgetown



Aguiar and Gopinath 2004: Defaultable Debt, Interest Rates and the Current Account

Aguiar and Gopinath 2004: Emerging Markets Business Cycles: The Cycle is the Trend

Arellano 2005: Default Risk, the Real Exchange Rate, and Income Fluctuations in Emerging Economies


Exchange Rate Dynamics


Alessandria 2005: Consumer Search, Price Dispersion, and International Relative Price Volatility

Atkeson and Burstein 2005: Trade Costs, Pricing to Market, and International Relative Prices mimeo UCLA

Burstein, Neves and Rebelo 2003: Distribution Costs and Real Exchange Rate Dynamics During Exchange-Rate-Based Stabilizations, JME

Chari, Kehoe and McGrattan 2002: Can sticky price models generate volatile and persistent real exchange rates? REStud 69/3