FDI: making a contribution to international business cycles literature
An implicit assumption in (almost) entire open economy macro literature is that of essentially infinite elasticity of substitution between domestic and foreign capital (they are perfect substitutes, money is money). This implies that gross FDI flows are irrelevant and all work so far focused on net FDI flows. We show that this is an excessive simplification. In this paper, with wonderful Alex McQuoid and Kathy Smith we show that there is positive co-movement of gross FDI flows (at least within the EU countries, for which we use the data), which would be hard to rationalize in the standard framework. We extend the Backus-Kehoe-Kydland framework to account for imperfect substitution and study the implications. The main challenge with such papers is how to position them in the literature. We received really useful comments during the Summer Workshop!