Working Paper: NBER ID: w13613
Authors: Christopher J. Erceg; Christopher Gust; 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 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.
Keywords: Open Economy; Domestic Shocks; Trade Openness; DSGE Model
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 |
|---|---|
| Increased trade openness (F19) | modifies the wedge between consumer and domestic prices (F16) |
| Increased trade openness (F19) | reduction in the output response to government spending shocks (E62) |
| Higher openness increases the effective interest elasticity of the economy (F41) | reduction in the output response to government spending shocks (E62) |
| Increased trade openness (F19) | flattening of the marginal rate of substitution (MRS) schedule (D11) |
| flattening of the marginal rate of substitution (MRS) schedule (D11) | affects labor supply responses to shocks (J22) |
| Increased trade openness (F19) | divergence of effects of domestic shocks on output and inflation (F62) |
| Higher trade price elasticity and Frisch elasticity of labor supply (F16) | divergence of effects of domestic shocks on output and inflation (F62) |
| Increased trade openness (F19) | modest differences in responses to shocks between open and closed economies (F41) |