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Putting Up a Good Fight: The Galí-Monacelli Model versus “The Six Major Puzzles in International Macroeconomics”

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  • Stefan Ried

Abstract

In this paper, the following question is posed: Can the New Keynesian Open Economy Model by Galí and Monacelli (2005b) explain “Six Major Puzzles in International Macroeconomics”, as documented in Obstfeld and Rogoff (2000b)? The model features a small open economy with complete markets, Calvo sticky prices and monopolistic competition. As extensions, I explore the effects of an estimated Taylor rule and additional trade costs. After translating the six puzzles into moment conditions for the model, I estimate the five most effective parameters using simulated method of moments (SMM) to fit the moment conditions implied by the data. Given the simplicity of the model, its fit is surprisingly good: among other things, the home bias puzzles can easily be replicated, the exchange rate volatility is formidably increased and the exchange rate correlation pattern is relatively close to realistic values. Trade costs are one important ingredient for this finding.

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Bibliographic Info

Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2009-020.

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Length: 46 pages
Date of creation: Apr 2009
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Handle: RePEc:hum:wpaper:sfb649dp2009-020

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Keywords: International Macroeconomics; New Keynesian open economy model; trade costs; simulated method of moments (SMM);

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