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: www.cepr.org/pubs/dps/DP6574.asp.asp

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.