Productivity shocks and monetary policy in a two-country model

Tae-Seok Jang and Eiji Okano ()

No 29, Dynare Working Papers from CEPREMAP

Abstract: In this paper, we examine the effects of foreign productivity shocks on monetary policy in a symmetric open economy. Our two-country model incorporates the New Keynesian features of price stickiness and monopolistic competition based on the cost channel of Ravenna and Walsh (2006). In particular, in response to asymmetric productivity shocks, firms in one country achieve a more efficient level of production than those in another economy. Because the terms of trade are directly affected by changes in both economies’ output levels, international trade creates a transmission channel for inflation dynamics in which a deflationary spiral in foreign producer prices reduces domestic output. When there is a decline in economic activity, the monetary authority should react to this adverse situation by lowering the key interest rate. The impulse response function from the model shows that a productivity shock can cause a real depreciation of the exchange rate when economies are closely integrated through international trade.

Keywords: cost channel; new Keynesian model; productivity shocks; terms of trade; two-country model (search for similar items in EconPapers)
JEL-codes: E24 E31 J3 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2013-12
New Economics Papers: this item is included in nep-dge, nep-int, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Journal Article: Productivity Shocks and Monetary Policy in a Two-Country Model (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:cpm:dynare:029

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