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Macroeconomic Interdependence in a Two-Country DSGE Model under Diverging Interest-Rate Rules

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Abstract

The present article extends a variant of the Obstfeld/Rogoff (2001) two-country DSGE model by introducing Calvo (1983) pricing. It is possible to collapse the model into a canonical log-linear representation consisting of two dynamic IS and two New Keynesian Phillips curves. Re°ecting the di®ering statutes of the ECB and the Fed, two diverging interest-rate rules are introduced. For a sensible calibration of the model we can derive a locally unique rational expectations equilibrium. Furthermore, we ¯nd that aggregate productivity shocks, which are assumed to be positively correlated across countries, have a negative impact on domestic and foreign output, a phenomenon already described for the closed economy by Gal¶³ (2002). Cost-push as well as contractionary monetary policy shocks, which are assumed to be country-speci¯c, also have a negative impact on domestic and foreign output since the economies are interdependent due to terms-of-trade externalities. Contrary to Corsetti/Pesenti (2001), expansionary monetary policy shocks always have a "prosper thyself" and "beggar thy neighbor" e®ect since they in°uence the terms of trade bene¯cially for the respective country's resident households. Finally, if the ECB implemented the interest-rate rule proposed in the present article, it would encounter lower °uctuations in European producer price in°ation compared to an interest-rate rule as proposed for the Fed. This is consistent with the ECB's paramount objective of price stability. However, this advantage only holds at the expense of relatively high °uctuations in the European output gap.

Suggested Citation

  • Ulrich Gunter, 2009. "Macroeconomic Interdependence in a Two-Country DSGE Model under Diverging Interest-Rate Rules," Vienna Economics Papers 0903, University of Vienna, Department of Economics.
  • Handle: RePEc:vie:viennp:0903
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    Cited by:

    1. Fujisaki, Seiya, 2012. "Interest Rate Control Rules and Macroeconomic Stability in a Heterogeneous Two-Country Model," MPRA Paper 37017, University Library of Munich, Germany.

    More about this item

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications

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