Demand Shocks and Intertemporal Coordination: A Two Country Model

Francesco Saraceno ()
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Francesco Saraceno: OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po

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Abstract: The effect of demand shocks is studied within an economy characterized by a temporally articulated production structure and bound by rational agents. Hicks' (1973) model is extended in order to include trade between two economies with demand links. This allows to tackle issues as the transmission of shocks and the coordination of monetary policies. By means of numerical simulations the author shows that because of irreversibilities, temporary demand shocks trigger disequilibrium dynamics with permanent effect on the economy. Market imperfections, namely a certain degree of wage and price stickiness, prove necessary to avoid the implosion of the system. An accommodating monetary policy, by softening financial constraints, is effective in stabilizing the economy. When considering trading economies, a certain degree of openness has positive effects, and independent monetary policies may in some occasions be desirable.

Date: 2005
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Published in ICFAI Journal of Monetary Economics, 2005, 3 (2), pp.51 - 75

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