Exercise 9.15

The Importance of Interest-Rate and Endowment Shocks

⬅ Return

Problem

Consider the two-sector open economy with staggered price setting `a la Calvo-Yun studied in Section 9.16. As an identification assumption, postulate that interest-rate shocks can affect \(r_t\) and \(y^T_t\) contemporaneously and that output shocks can affect \(y^T_t\) but not \(r_t\) contemporaneously.

1. Compute the matrix \(\Gamma\) under this identification scheme.

2. Compute the share of the variances of tradable output, \(y^T_t\); hours, \(h_t\); consumption, \(c_t\); the real exchange rate, \(p_t\); and the trade-balance-to-output ratio, \(tb_t/(y^T_t+p_ty^N_t)\) explained by interest-rate shocks under the two alternative exchange-rate policies considered in that Section 9.16, the optimal exchange-rate policy and a currency peg. Comment.

3. Produce two figures, similar to Figure 9.19, displaying the dynamics of a typical external crisis, conditional on each of the two shocks. Provide intuition.

4. What fraction of the welfare costs of currency pegs reported in Table 9.9 is attributable to interest-rate shocks?

5. Answer the questions 1-4 above under the alternative identification assumption that output shocks can affect the interest contemporaneously but not vice versa.

Answer

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