4.1 Steady state
In this section, we will examine the deterministic steady sate with zero inflation. In the steady state, we assume that the price of capital q= and the nominal exchange rate is 1 equal to 1. Moreover, to simplify the analysis, we assume that P P= d =Pm =Px = 1 and the world price index for the rest of the world P* =0.67. The international interest rates,RB* and R* are specified as 0.01, following Kollmann (2002). Moreover, according to GM (2007), gb is the constant share of the government bonds to consumption and is assumed to be 0.6 in the steady state. As a result, Eqs. (1) & (2), (4) - (21) will be degenerated to nine equations for nine endogenous variables
, *
, , , , , , , B c l n w λ Ω K b R .
The steady-state conditions can be stated as below. Firstly, the combination of Eq. (7), (8), (9)
1
1 1
V qK n
Z gb c c
α α
τ
⎛ ⎞ ⎛ ⎞−
= − ⎜⎝ + ⎟ ⎜ ⎟⎠ ⎝ ⎠
Θ (34)
Then Eqs. (10) – (14), (6) can be stated as follows:
gb qK c Ω = α
+Θ (35)
1
After these seven steady-state variables are obtained from Eqs. (33) to (39), we can derive RB* and b from the Euler equations associated with the home and foreign * bonds, and the current account balance by combining Eqs.(4), (6), and (21).
(
*)
After solving the core model, we can easily solve the steady-state level of
, , ,
T IB L D
R R R R and the EFP from the interest rate conditions Eqs. (28) – (31).
4.2 Model Parameterization
Now we calibrate the model with the appropriate specification of parameter values. In particular, we will emphasize the importance of the banking sector and how much the economic openness matters.
Firstly, we set the quarterly discount factor β to 0.99, and δ =0.025 for the quarterly depreciation rate as the conventional setting. ψ is assumed to be 0.48 to generate the reasonable labor input in the production sector which is approximately
1/ 3 of the total time endowment. αm =0.3 is specified so that the steady-state imports/GDP ratio is 30%, consistent with the Germany and U.K. data. The steady-state price-marginal cost markup factor for goods produced by the domestic firms is set at
( )
/ 1 1.1
ν ν − = , and the price elasticity for all goods in the economy and the rest of the world is chosen θ μ= = . Following GM (2007), we choose 5 η =0.36 to reflect the relative shares of capital and labor in the goods production.
Then there are the parameters related to money and banking sector need to be determined. The velocity of monetary turnover rate is specified as V =0.4, and the bank reserve ratio is equal to 0.005.a The parameters in the loan production are
, ,Z α
Θ , and are assumed to be 0.2, 10, 0.65, following the specification in GM (2007).
In the steady state, we let the bond rate R* =0.01. φ=0.002 is the value of panel regression for 21 OECD countries by Milesi-Ferretti & Lane (2001).
4.3 Numerical results
The steady-state results of the baseline model are summarized in Table 1. Since the steady state is in the zero inflation condition, all the interest rates are in the “real” term.
Firstly, the total labor l n+ ≈33.69% is a reasonable value close to 1/ 3that is generally accepted in the business cycle literature. Because we set the world interest rate R* =1% as the normal level, other rates are determined accordingly from the interest rate relationships in Section 3. As shown, the loan rate R is about 0.56% tL quarterly, the interbank rate is 0.32% and consequently the EFP is at the level around
a V =0.31in Goodfriend & McCallum(2007), but the interest rates will be negative in this study with the same velocity.
Table1: Benchmark model
(
Z =10, αm =0 3.)
0.24%. While various interest rates in the model are in different levels, if the central bank uses only one interest rate for the monetary policy making, it may lead to misjudgments.
Furthermore, we calibrate two more cases to examine the significance of banking sector and economic openness in an economy. First, we consider a highly efficient financial market by specifying Z to be 10 times higher than the benchmark model.
The calibration outcomes are listed in Table 2. Under the assumption of perfectly competitive bank industry and the bank which could produce loans in a highly efficient way, all the interest rates converge to R . Therefore, the EFP is driven down to a level * close to zero and so is the labor in the banking sector. Indeed, the high efficiency of the banking sector can successfully reduce the EFP in a small open economy as in a closed economy, which signals the worsening of the asymmetric information problem on the credit market.
The other case is the lower openness of the country by letting αm to be equal to 0.1.
The calibration outcome is presented in Table 3. By comparing Table 2 and 3, we can see that consumption rises with the openness of trades, but capital drops. The most significant change is the rise in the steady-state real current account balance as shown by b . As shown in Eq. (39), the accumulation of the international bonds must be * accompanied by excess imports. While the trade deficit rises with the degree of openness, the bonds needed are greater. Furthermore, stronger consumption demand
Variable c c A l n w K b * b
Steady State 1.2399 1.5294 0.3363 0.0035 2.0799 11.575 32.712 0.7439 Variable R IB R B R L R T R D λ Ω EFP Steady State 0.00323 0.0041 0.0056 0.01 0.00322 0.3787 0.2635 0.0024
Table2: Highly efficient banking system
(
Z =90, αm =0 3.)
Table3: Less open market
(
Z =10, αm=0 1.)
due to greater openness induces higher demand for deposits, and thus causes lower interest rates in the steady state. However, this results in a higher level of EFP.