Chapter

The Transmission of Domestic Shocks in Open Economies

Edited by Christopher Erceg, Christopher Gust and David López-Salido

in International Dimensions of Monetary Policy

Published by University of Chicago Press

Published in print March 2010 | ISBN: 9780226278865
Published online February 2013 | e-ISBN: 9780226278872 | DOI: http://dx.doi.org/10.7208/chicago/9780226278872.003.0003
The Transmission of Domestic Shocks in Open Economies

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This chapter analyzes the extent to which openness to trade may influence the economy's response to domestic shocks. The analysis is conducted in terms of two models, that is, a medium-scale two-country model used at the Federal Reserve Board for policy simulations (known as SIGMA), and a two-country version of the Erceg-Henderson-Levin model. The effects of three domestic shocks in each of the models, that is, a permanent decline in the inflation target, a persistent increase in government spending, and a persistent technology shock are examined. The findings are summarized as any substantial differences observed in the volatility and persistence of output and domestic inflation between highly open and relatively closed (but otherwise similar) economies will hardly be attributable to differences in the propagation mechanisms of domestic shocks, but rather must be the consequence of their differential response to shocks in the rest of the world.

Keywords: domestic shocks; two-country model; inflation; openness; volatility; SIGMA; open economies

Chapter.  22037 words.  Illustrated.

Subjects: Macroeconomics and Monetary Economics

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