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Frontiers of Economics in China

ISSN 1673-3444

ISSN 1673-3568(Online)

CN 11-5744/F

Postal Subscription Code 80-978

Front. Econ. China    2015, Vol. 10 Issue (1) : 7-37
research-article |
Productivity Shocks and Monetary Policy in a Two-Country Model
Tae-Seok Jang1(),Eiji Okano2()
1. Graduate School of International Studies, Korea University, Seoul, 136-1701, Republic of Korea
2. Graduate School of Economics, Nagoya City University, Nagoya-shi, Aichi 467-8501, Japan
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In this paper, we examine the effects of foreign productivity shocks on monetary policy in a symmetric open economy. Our two-country model incorporates the New Keynesian features of price stickiness and monopolistic competition based on the cost channel of Ravenna and Walsh (2006). In particular, in response to asymmetric productivity shocks, firms in one country achieve a more efficient level of production than those in another economy. Because the terms of trade are directly affected by changes in both economies’ output levels, international trade creates a transmission channel for inflation dynamics in which a deflationary spiral in foreign producer prices reduces domestic output. When there is a decline in economic activity, the monetary authority should react to this adverse situation by lowering the key interest rate. The impulse response function from the model shows that a productivity shock can cause a real depreciation of the exchange rate when economies are closely integrated through international trade.

Keywords cost channel      New Keynesian model      productivity shocks      terms of trade      two-country model     
Issue Date: 23 March 2015
 Cite this article:   
Tae-Seok Jang,Eiji Okano. Productivity Shocks and Monetary Policy in a Two-Country Model[J]. Front. Econ. China, 2015, 10(1): 7-37.
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