Trade openness, financial openness, and macroeconomic volatility

This paper develops a new model of an open economy for a study of macroeconomic dynamics under different degrees of trade and financial openness. The model is estimated using quarterly data on the Chinese economy over the period 2005Q3-2020Q4 and then applied to analyze how macroeconomic volatility varies with trade and financial openness in several representative settings. We find that the impacts on macroeconomic volatility of trade openness and financial openness depend on the nature of the underlying shocks and a moderate degree of trade openness, together with a high degree of financial openness, yield the optimal welfare results in most cases. These results highlight that the effects of trade and financial openness on macroeconomic volatility differ in various situations and that their interactions can lead to different welfare results.