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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. Maurice Obstfeld & Kenneth Rogoff, 1994. "Exchange Rate Dynamics Redux," NBER Working Papers 4693, National Bureau of Economic Research, Inc.
  2. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Optimal Fiscal and Monetary Policy Under Sticky Prices," Departmental Working Papers 200105, Rutgers University, Department of Economics.
  3. Michael B. Devereux & Charles Engel, 2002. "Exchange Rate Pass-Through, Exchange Rate Volatility, and Exchange Rate Disconnect," NBER Working Papers 8858, National Bureau of Economic Research, Inc.
  4. Devereux, Michael B & Sutherland, Alan, 2006. "Solving for Country Portfolios in Open Economy Macro Models," CEPR Discussion Papers 5966, C.E.P.R. Discussion Papers.
  5. Thomas Lubik & Frank Schorfheide, 2003. "Do Central Banks Respond to Exchange Rate Movements? A Structural Investigation," Economics Working Paper Archive 505, The Johns Hopkins University,Department of Economics.
  6. Lane, Philip R., 1999. "The New Open Economy Macroeconomics: a Survey," CEPR Discussion Papers 2115, C.E.P.R. Discussion Papers.
  7. James E. Anderson & Eric van Wincoop, 2000. "Gravity with Gravitas: A Solution to the Border Puzzle," Boston College Working Papers in Economics 485, Boston College Department of Economics.
  8. Bennett T McCallum & Edward Nelson, 2001. "Monetary Policy for an Open Economy: An Alternative Framework with Optimising Agents and Sticky Prices," Discussion Papers 05, Monetary Policy Committee Unit, Bank of England.
  9. Benigno, Pierpaolo, 2004. "Optimal monetary policy in a currency area," Journal of International Economics, Elsevier, vol. 63(2), pages 293-320, July.
  10. Richard Clarida & Jordi Gali & Mark Gertler, 1997. "Monetary Policy Rules in Practice: Some International Evidence," NBER Working Papers 6254, National Bureau of Economic Research, Inc.
  11. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," International Trade 0012003, EconWPA.
  12. Nicolas Coeurdacier, 2006. "Do trade costs in goods market lead to home bias in equities?," 2006 Meeting Papers 111, Society for Economic Dynamics.
  13. Kollmann, R., 1996. "The Exchange rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities : A Quantitative Investigation," Discussion Paper 1996-67, Tilburg University, Center for Economic Research.
  14. Jermann, Urban J., 1998. "Asset pricing in production economies," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 257-275, April.
  15. Andrew Levin & Christopher J. Erceg & Dale W. Henderson, 1999. "Optimal Monetary Policy with Staggered Wage and Price Contracts," Computing in Economics and Finance 1999 1151, Society for Computational Economics.
  16. Midrigan, Virgiliu, 2007. "International price dispersion in state-dependent pricing models," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2231-2250, November.
  17. Adolfson, Malin & Laseen, Stefan & Linde, Jesper & Villani, Mattias, 2007. "Bayesian estimation of an open economy DSGE model with incomplete pass-through," Journal of International Economics, Elsevier, vol. 72(2), pages 481-511, July.
  18. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  19. McCallum, John, 1995. "National Borders Matter: Canada-U.S. Regional Trade Patterns," American Economic Review, American Economic Association, vol. 85(3), pages 615-23, June.
  20. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  21. Flood, Robert P & Rose, Andrew K, 1993. "Fixing Exchange Rates: A Virtual Quest for Fundamentals," CEPR Discussion Papers 838, C.E.P.R. Discussion Papers.
  22. Hau, Harald, 2002. "Real Exchange Rate Volatility and Economic Openness: Theory and Evidence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(3), pages 611-30, August.
  23. Piet Sercu & Rosanne Vanpée, 2008. "Estimating the Costs of International Equity Investments," Review of Finance, European Finance Association, vol. 12(4), pages 587-634.
  24. repec:spo:wpmain:info:hdl:2441/c8dmi8nm4pdjkuc9g708n2m4m is not listed on IDEAS
  25. Martin Feldstein & Charles Horioka, 1979. "Domestic Savings and International Capital Flows," NBER Working Papers 0310, National Bureau of Economic Research, Inc.
  26. 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.
  27. repec:spo:wpecon:info:hdl:2441/c8dmi8nm4pdjkuc9g708n2m4m is not listed on IDEAS
  28. Paolo Pesenti, 2008. "The Global Economy Model: Theoretical Framework," IMF Staff Papers, Palgrave Macmillan, vol. 55(2), pages 243-284, June.
  29. Charles Engel, 2000. "Comments on Obstfeld and Rogoff's "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?"," NBER Working Papers 7818, National Bureau of Economic Research, Inc.
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