Title: The dynamics of external reaction functions: The role of financial globalization and risk aversion
Authors: Juan Sapena - Catholic University of Valencia (Spain) [presenting]
Mariam Camarero - University Jaume I (Spain)
Cecilio Tamarit - University of Valencia (Spain)
Abstract: The aim is to reexamine the issue of the external sustainability in a dynamic framework. The emergence of large and persistent external imbalances is one of the most crucial events in international finance. We depart from standard empirical tests of intertemporal sustainability conditions, by following the approach initiated by Henning Bohn, that proposes the estimation of a linear reaction function for the trade balance to a measure of external debt position, such as net foreign liabilities. To estimate the fiscal reaction function, we extend Bohn's approach into a time-varying external reaction function for a group of 17 countries panel, paying special attention to Eurozone members, but also including some relevant OECD countries as well for the period 1970-2016. The main advantage of our empirical approach is that it captures the dynamics of the external reaction function, in search of main sources of heterogeneity among EMU countries. In particular, we explore the incidence of financial globalization and global risk aversion on the dynamics of the model for the selected countries along the period considered. For the estimation of the model, we employ a State-Space framework for modeling panel time series, which extends the simple framework generally employed at the literature, into a panel-data time-varying parameters framework, combining both fixed (either common and country-specific) and varying components.