gali_monacelli

gali_monacelli - Monetary Policy and Exchange Rate...

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Monetary Policy and Exchange Rate Volatility in a Small Open Economy Jordi Gali and Tommaso Monacelli
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The Model • The world economy as a continuum of small open economies represented by the unit interval. • Since each economy is of measure zero, its domestic policy decisions do not have any impact on the rest of the world. • While different economies are subject to imperfectly correlated productivity shocks, we assume that they share identical preferences, technology, and market structure
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Households •M a x i m i z e where N t denotes hours of labour, and C t is a composite consumption index defined by
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Households where C H , t is an index of consumption of domestic goods given by the CES function where j [0, 1] denotes the good variety.
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Households and C F , t is an index of imported goods given by where C i , t is, in turn, an index of the quantity of goods imported from country i and consumed by domestic households. Parameter γ measures the substitutability between goods produced in different foreign countries.
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Households C i , t is given by an analogous CES function: where parameter ε >1 denotes the elasticity of substitution between varieties (produced within any given country).
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Households • In the composite consumption index parameter α∈ [0, 1] is (inversely) related to the degree of home bias in preferences, and is thus a natural index of openness.
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Households • In the composite consumption index parameter η > 0 measures the substitutability between domestic and foreign goods, from the viewpoint of the domestic consumer.
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Households •M a x i m i z e subject to the budget constraint
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where P i , t
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gali_monacelli - Monetary Policy and Exchange Rate...

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