DP6574 The Transmission of Domestic Shocks in Open Economies

Author(s): Christopher Erceg, Christopher Gust, J David López-Salido
Publication Date: November 2007
Keyword(s): imported intermediate inputs, open economy Phillips Curve, variable markups
JEL(s): E52, F41, F47
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6574

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 labour 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.