FRB: The Transmission of Domestic Shocks in the Open Economy

International Finance Discussion Papers

The Transmission of Domestic Shocks in the Open Economy
Christopher J. Erceg, Christopher Gust, and David Lopez-Salido
2007-906 (November 2007)

Abstract: This paper uses an open economy DSGE model to explore how trade openness affects the transmission of domestic shocks. For some calibrations, closed and open economies appear dramatically different, reminiscent of the implications of Mundell-Fleming style models. However, we argue such stark differences hinge on calibrations that impose an implausibly high trade price elasticity and Frisch elasticity of labor supply. Overall, our results suggest that the main effects of openness are on the composition of expenditure, and on the wedge between consumer and domestic prices, rather than on the response of aggregate output and domestic prices.

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Keywords
Open economy Phillips Curve, Variable markups, Imported intermediate inputs

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Last update: November 16, 2007