Home-product bias, capital mobility, and macroeconomic volatility

This paper uses a dynamic general equilibrium two-country optimizingmodel to analyse the consequences of international capital mobilityfor macroeconomic volatility. To this end, the dynamic macroeconomiceffects of a monetary policy, a fiscal policy, and a labor supplyshock are analysed. Simulations are used to analyse the implicationsof changes in the degree of capital mobility for the propagationof shocks. The simulation results obtained for a bond economyare compared with the simulation results obtained for a complete-marketeconomy. It is shown that allowing for a home-product bias inpreferences has a number of interesting implications for theway changes in international capital mobility and in the structureof international financial markets affect how shocks propagatethrough an open economy.