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Two-Country New Keynesian DSGE Model: A Small Open Economy as a Limit Case

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  • Marcos Antonio Coutinho da Silveira

Abstract

We build a two-country version of the model in Gali & Monacelli(2005), which extends for a small open economy the new KeynesainDSGE model used as tool for monetary policy analysis in closedeconomies. A distinctive feature of the model is that the terms oftrade enters directly into the new Keynesian Phillips curve as a newpushing-cost variable feeding the inflation. Furthermore, home bias inhouseholds? preferences allows for real exchange rate fluctuation, givingrise to alternative channels of monetary transmission. Unlike mostpart of the literature, the small domestic open economy is derived asa limit case of the two-coutry model, rather than assuming exogenousprocesses for the foreign variables. This procedure preserves the roleplayed by foreign nominal frictions in the way as international monetarypolicy shocks are conveyed into the small domestic economy.

Suggested Citation

  • Marcos Antonio Coutinho da Silveira, 2006. "Two-Country New Keynesian DSGE Model: A Small Open Economy as a Limit Case," Discussion Papers 1157, Instituto de Pesquisa Econômica Aplicada - IPEA.
    • Handle: RePEc:ipe:ipetds:1157
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    1. Claudio Soto, 2003. "Non-Traded Goods and Monetary Policy Trade-Offs in a Small Open Economy," Working Papers Central Bank of Chile 214, Central Bank of Chile.
    2. Clarida, Richard & Gali, Jordi & Gertler, Mark, 2002. "A simple framework for international monetary policy analysis," Journal of Monetary Economics, Elsevier, vol. 49(5), pages 879-904, July.
    3. Monacelli, Tommaso, 2003. "Monetary policy in a low pass-through environment," Working Paper Series 227, European Central Bank.
    4. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
    5. Tommaso Monacelli, 2003. "Monetary Policy in a Low Pass-Through Environment," Working Papers 228, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
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