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

  • Stefan Ried

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 Macroeconomicsâ€, 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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File URL: http://sfb649.wiwi.hu-berlin.de/papers/pdf/SFB649DP2009-020.pdf
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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
Date of revision:
Handle: RePEc:hum:wpaper:sfb649dp2009-020
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  1. Martin Uribe & Stephanie Schmitt-Grohe, 2001. "Optimal fiscal and monetary policy under sticky prices," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
  2. M.B. Devereux & Ch. Engel, 2003. "Exchange Rate Pass-Through, Exchange Rate Volatility, and ExchangeRate Disconnect," DNB Staff Reports (discontinued) 77, Netherlands Central Bank.
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  11. Flood, Robert P. & Rose, Andrew K., 1995. "Fixing exchange rates A virtual quest for fundamentals," Journal of Monetary Economics, Elsevier, vol. 36(1), pages 3-37, August.
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  18. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 624-60, June.
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  25. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  26. Paolo Pesenti, 2008. "The Global Economy Model: Theoretical Framework," IMF Staff Papers, Palgrave Macmillan, vol. 55(2), pages 243-284, June.
  27. Daniëls, Tijmen R. & Jager, Henk & Klaassen, Franc, 2011. "Currency crises with the threat of an interest rate defence," Journal of International Economics, Elsevier, vol. 85(1), pages 14-24, September.
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  31. Piet Sercu & Rosanne Vanpée, 2008. "Estimating the Costs of International Equity Investments," Review of Finance, European Finance Association, vol. 12(4), pages 587-634.
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