Globalization and Monetary Policy Institute
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The Globalization and Monetary Policy Institute Working Papers
2008 | 2007
2008
No. 11
Globalization and Monetary Policy: An Introduction
Enrique Martinez-Garcia
Abstract: Greater openness has become an almost universal feature of modern, developed economies. This paper develops a workhorse international model, and explores the role of standard monetary policy rules applied to an open economy. For this purpose, I build a two-country DSGE model with monopolistic competition, sticky prices, and pricing-to-market. I also derive the steady state and a log-linear approximation of the equilibrium conditions. The paper provides a lengthy explanation of the steps required to derive this benchmark model, and a discussion of: (a) how to account for certain well-known anomalies in the international literature, and (b) how to start "thinking" about monetary policy in this environment.
No. 10
Vehicle Currency
Michael B. Devereux and Shouyong Shi
Abstract: While in principle, international payments could be carried out using any currency or set of
currencies, in practice, the US dollar is predominant in international trade and financial
flows. The dollar acts as a "vehicle currency" in the sense that agents in nondollar economies
will generally engage in currency trade indirectly using the US dollar rather than using direct
bilateral trade among their own currencies. Indirect trade is desirable when there are
transactions costs of exchange. This paper constructs a dynamic general equilibrium model
of a vehicle currency. We explore the nature of the efficiency gains arising from a vehicle
currency, and show how this depends on the total number of currencies in existence, the size
of the vehicle currency economy, and the monetary policy followed by the vehicle currency's
government. We find that there can be very large welfare gains to a vehicle currency in a
system of many independent currencies. But these gains are asymmetry weighted towards the
residents of the vehicle currency country. The survival of a vehicle currency places natural
limits on the monetary policy of the vehicle country.
No. 9
Country Portfolios in Open Economy Macro Models
Michael B. Devereux and Alan Sutherland
Abstract: This paper develops a simple approximation method for computing equilibrium portfolios in
dynamic general equilibrium open economy macro models. The method is widely applicable,
simple to implement, and gives analytical solutions for equilibrium portfolio positions in any
combination or types of asset. It can be used in models with any number of assets, whether
markets are complete or incomplete, and can be applied to stochastic dynamic general
equilibrium models of any dimension, so long as the model is amenable to a solution using
standard approximation methods. We first illustrate the approach using a simple two-asset
endowment economy model, and then show how the results extend to the case of any
number of assets and general economic structure.
No. 8
How Should Central Banks Define Price Stability?
Mark A. Wynne
Abstract: It is now generally accepted that the primary objective of central banks should be the maintenance of price stability. This paper considers the question of how central banks should define price stability. I address three specific questions. First, should central banks target broad or narrow measures of inflation? Second, should central banks target headline or core measure of inflation? And third, should central banks define price stability as prevailing at some positive measured rate of inflation?
No. 7
Accounting for Persistence and Volatility of Good-level Real Exchange Rates: The Role of Sticky Information
Mario J. Crucini, Mototsugu Shintani and Takayuki Tsuruga
Abstract: Volatile and persistent real exchange rates are observed not only in aggregate series but also
on the individual good level data. Kehoe and Midrigan (2007) recently showed that, under a
standard assumption on nominal price stickiness, empirical frequencies of micro price
adjustment cannot replicate the time-series properties of the law-of-one-price deviations. We
extend their sticky price model by combining good specific price adjustment with
information stickiness in the sense of Mankiw and Reis (2002). Under a reasonable
assumption on the money growth process, we show that the model fully explains both
persistence and volatility of the good-level real exchange rates. Furthermore, our framework
allows for multiple cities within a country. Using a panel of U.S.-Canadian city pairs, we
estimate a dynamic price adjustment process for each 165 individual goods. The empirical
result suggests that the dispersion of average time of information update across goods is
comparable to that of average time of price adjustment.
No. 6
Driving Forces of the Canadian Economy: An Accounting Exercise
Simona E. Cociuba and Alexander Ueberfeldt
Abstract: This paper analyzes the Canadian economy for the post-1960 period. It uses an accounting
procedure developed in Chari, Kehoe, and McGrattan (2006). The procedure identifies
accounting factors that help align the predictions of the neoclassical growth model with
macroeconomic variables observed in the data. The paper finds that total factor productivity
and the consumption-leisure trade-off—the productivity and labor factors—are key to
understanding the changes in output, labor supply and labor productivity observed in the
Canadian economy. The paper performs a decomposition of the labor factor for Canada and
the United States. It finds that the decline in the gender wage gap is a major driving force of
the decrease in the labor market distortions. Moreover, the milder reduction in the labor
market distortions observed in Canada, compared to the US, is due to a relative increase in
effective labor taxes in Canada.
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