Working Paper: CEPR ID: DP6574
Authors: Christopher Erceg; Christopher Gust; J. David López-Salido
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 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.
Keywords: Imported Intermediate Inputs; Open Economy; Phillips Curve; Variable Markups
JEL Codes: E52; F41; F47
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| trade openness (F43) | wealth effect of shocks on labor supply (H31) |
| wealth effect of shocks on labor supply (H31) | aggregate supply (E23) |
| aggregate supply (E23) | domestic inflation (E31) |
| trade openness (F43) | effective interest elasticity of the economy (E20) |
| effective interest elasticity of the economy (E20) | response of output to domestic shocks (F41) |
| effective interest elasticity of the economy (E20) | response of inflation to domestic shocks (E31) |
| trade openness (F43) | composition of expenditure (E20) |
| composition of expenditure (E20) | output responses (C67) |
| nominal wage rigidities (J31) | response of domestic prices to shocks (E30) |
| trade openness (F43) | inflation dynamics (E31) |