Identification Robust Empirical Evidence on the Open Economy IS-Curve

Abstract

Existing empirical evidence on the Euler equation based on closed economy models suggests low responsiveness of aggregate consumption to changes in interest rates. We incorporate open economy features and consider extensions that include habit formation and hand-to-mouth consumers. For several open economies and applying econometric methods that are robust to weak instruments and structural changes, we continue to find low values for the elasticity of intertemporal substitution, implying a small effect of real interest rate changes on aggregate income. In some countries, structural changes are informative for identification, but otherwise aggregate data provide limited information to learn about IS-curve specifications.