The Monetary Policy Implications of Market Reforms
and Trade Integration
Matteo Cacciatore
HEC Montréal
Fabio Ghironi
University of Washington, CEPR, and NBER
CEPR-RIETI Workshop
“New Challenges to Global Trade and Finance”
RIETI, Tokyo, October 8, 2013
Introduction
• A frequent statement in policy circles: Market reforms that facilitate product creation and
enhance labor market flexibility would be beneficial for rigid economies, such as those of
several European countries.
– More flexible markets would foster more rapid recovery from recessions and, in general,
would result in better economic performance.
– Deregulation of product markets would accomplish this by boosting business creation
and enhancing competition;
– Deregulation of labor markets would do it by facilitating reallocation of resources and
speeding up the adjustment to shocks.
1
Introduction, Continued
• Results in the academic literature support these arguments.
– Blanchard and Giavazzi (2003), Cacciatore and Fiori (2011), Dawson and Seater (2011),
Ebell and Haefke (2009), and several others.
• But the implementation of market reforms that alter important characteristics of a wide set
of European countries would have implications that extend beyond Europe.
• The reforms would have consequences for the optimal conduct of macroeconomic policy in
Europe and, potentially, outside.
• The same can be said of increased trade integration between Europe and its partners.
2
This Presentation
• I will present results on the macroeconomic and monetary policy consequences of market
reforms and trade integration from a research agenda with Matteo Cacciatore.
• Two papers: The paper that was distributed (focusing mostly on market reforms) and a
companion paper (focusing on trade integration).
• Results obtained using a two-country, dynamic, stochastic, general equilibrium model with
heterogeneous firms, endogenous producer entry into domestic and export markets, and
labor market frictions.
• The model builds on Ghironi and Melitz (2005—international trade and macro dynamics
with heterogeneous firms) and Cacciatore’s (2010) extension to incorporate search-andmatching labor market frictions.
• We augment the framework by introducing sticky prices and wages, and a role for monetary
policy.
• The (calibrated) model successfully reproduces several features of the (U.S. and Euro Area)
business cycle.
3
International Trade and the Macroeconomy
• Experiment 1. Trade Integration: Lower (iceberg) trade costs to levels consistent with
post-1980s trade volumes.
• Trade integration reallocates market share toward more productive firms, and it increases
business cycle synchronization across countries.
– Consistent with empirical evidence (Frankel and Rose, 1998, and Clark and van Wincoop,
2001) that poses challenge to standard open economy New Keynesian models without
“deep” trade features (Faia and Monacelli, 2008, Pappa, 2004, others).
4
International Trade and Monetary Policy
• When trade linkages are weak, (Ramsey) optimal, cooperative policy is inward-looking, but it
requires significant departures from price stability both in the long run and over the business
cycle.
• As trade integration reallocates market share toward more productive firms, optimal long
run inflation falls.
• Increased business cycle synchronization implies that country-specific shocks have more
global consequences.
• The constrained efficient allocation generated by optimal cooperative policy can still be
achieved by appropriately designed inward-looking policy rules, but sub-optimal (historical)
policy implies inefficient fluctuations in cross-country demands that result in large welfare
costs when trade linkages are strong.
– Benigno and Benigno (2003).
5
Market Reforms and the Macroeconomy
• Experiment 2. Market Reforms: Euro Area producer entry costs, unemployment benefits,
worker bargaining power lowered to U.S. levels.
• Reforms result in increased domestic producer entry and lower unemployment at home and
abroad, but a worse domestic external balance, at least for some time.
• By putting upward pressure on labor costs, producer entry implies stronger terms of trade
during much of the transition.
– Corsetti, Martin, and Pesenti (2013).
6
Market Reforms and Monetary Policy
• When regulation is high, (Ramsey) optimal, cooperative policy requires significant
departures from price stability both in the long run and over the business cycle (as in the
case of low trade).
• Adjustment to market reforms requires expansionary policy to reduce transition costs, but
deregulation reduces static and dynamic inefficiencies, making price stability more desirable
at home and abroad once the transition is complete.
• Optimal cooperative monetary policy maximizes the benefits of market reforms at home and
abroad, with non-negligible welfare gains relative to historical policy behavior.
– We follow Sims (2007) in considering historical behavior a more realistic benchmark for
comparison than optimal, non-cooperative policies.
7
Related Literature
• Market reforms and the macroeconomy: Bertinelli, Cardi, and Sen (2013), Blanchard and
Giavazzi (2003), Cacciatore and Fiori (2011), Dawson and Seater (2011), Ebell and Haefke
(2009), Felbermayr and Prat (2011), Fiori, Nicoletti, Scarpetta, and Schiantarelli (2012),
Griffith, Harrison, and Macartney (2007), and Messina and Vallanti (2007).
– Closed economy.
• Market reforms and macro policy: Barkbu, Rahman, Valdés, and Staff (2012), Eggertsson,
Ferrero, and Raffo (2013), Fernández-Villaverde, Guerrón-Quintana, and Rubio-Ramírez
(2011).
– No deep modeling of producer entry dynamics and labor market frictions.
• Optimal monetary policy and producer entry: Cacciatore, Fiori, and Ghironi (2013), Bergin
and Corsetti (2008, 2013), Bilbiie, Fujiwara, and Ghironi (2011), Faia (2010), Lewis (2010).
– Mostly closed economy. Bergin and Corsetti (2013) exception.
8
Related Literature, Continued
• Monetary transmission and optimal monetary policy in New Keynesian models:
– Labor market frictions: Arseneau and Chugh (2008), Faia (2009), Thomas (2008).
– Price stability in open economies: Benigno and Benigno (2003, 2006), Catão and Chang
(2012), Galí and Monacelli (2005), Dmitriev and Hoddenbagh (2012), many others.
– Do not feature mechanisms we focus on.
• Krugman’s (1995) call: “I would like to know how the macroeconomic model that I more or
less believe can be reconciled with the trade models that I also more or less believe. [...]
What we need to know is how to evaluate the microeconomics of international monetary
systems. Until we can do that, we are making policy advice by the seat of our pants.”
9
Margins and Distortions
• The worldwide Ramsey planner uses its policy instruments (Home and Foreign interest
rates in the model) to address the consequences of a set of distortions.
• I will not go into the details of the model, but I will summarize the sources of inefficiency with
reference to the margins on which they impinge.
• Price and wage stickiness, firm monopoly power, positive unemployment benefits, “red
tape” regulation, and incomplete asset markets affect four margins of adjustment and the
resource constraint for consumption output in the market economy.
10
1. Product Creation Margin
• Sticky prices result in inefficient time-variation and lack of synchronization of domestic and
export markups that introduce inefficiency in the product creation margin (described by the
Euler equations for product creation at Home and abroad).
– Time variation and lack of synchronization of markups across markets imply inefficient
deviations of the monopoly profit incentive for product creation (the markup) from the
welfare benefit of product variety determined by the constant elasticity of substitution
across products.
• Moreover, the product creation margin is affected by the presence of the non-technological
entry costs.
• The Euler equations for domestic and foreign product creation coincide with those of the
first-best environment only when prices and wages are flexible and there is no “red tape.”
11
2. Job Creation Margin
• This margin of adjustment is described by the Euler equations for job creation in the two
countries.
• Monopoly power in the final consumption sector distorts the job creation decision by
inducing a suboptimally low return from vacancy posting in the intermediate sector.
– Price stickiness impacts this departure from efficiency by inducing endogenous markup
variation.
• Failure of the Hosios condition (for which equality of the firm’s bargaining share and the
vacancy elasticity of the matching function is necessary for efficiency) is an additional
distortion in this margin.
– This is affected both by the flexible-wage value of the bargaining share and the presence
of wage stickiness, which induces time variation of the bargaining share.
· Sticky wages are sufficient to generate a wedge between private and social returns to
vacancy posting.
• Sticky wages distort job creation also by affecting the outside option of firms through the
cost of wage adjustment.
• Finally, unemployment benefits increase the workers’ outside option above its efficient level.
12
3. Labor Supply Margin
• With endogenous labor supply, monopoly power in product markets induces a misalignment
of relative prices between consumption goods and leisure.
– This is the distortion that characterizes standard New Keynesian models without labor
market frictions and endogenous product dynamics.
• Sticky prices induce time variation of this distortion.
13
4. Cross-Country Risk Sharing Margin
• Incomplete markets imply inefficient risk sharing between Home and Foreign households:
– The ratio of marginal utilities of consumption at Home and abroad is not tied to the
welfare-based real exchange rate.
• The departure of consumption dynamics from the perfect risk sharing outcome is also
affected by costs of adjusting bond holdings.
14
Resource Constraint
• Sticky prices and wages and the non-technological portion of product creation costs imply
inefficient diversion of resources from consumption and creation of new products and
vacancies.
15
Trade Costs and the Export Entry Margin
• Implicit in the discussion above is that all trade costs in our model are treated as determined
by trade technology—i.e., they are not the result of trade barriers and (sub-optimal) trade
policy.
• If we allow for part of fixed and iceberg trade costs to be the result of trade barriers and
sub-optimal trade policy, then these costs also create distortions.
• They distort the export entry margin and, by impacting the profitability of firms, they impact
the product creation margin.
• Note: Introducing this interpretation would not change our results—we would simply be
viewing trade integration as a reduction of policy-induced impediments to trade.
16
The Role of Monetary Policy
• The market allocation is efficient only if all the distortions are zero at all points in time.
• We abstract from optimal fiscal policy, and we allow for asymmetric shocks.
• Hence, we work in a second-best environment in which the efficient allocation cannot be
achieved.
• The worldwide Ramsey central bank of the optimal, cooperative scenario uses its leverage
on the economies via the sticky-price and sticky-wage distortions, trading off their costs
against the possibility of addressing the distortions that characterize the market economy
under flexible wages and prices.
17
Some Intuition for Results
• Optimal policy uses inflation to narrow inefficiency wedges relative to the efficient allocation
along the economies’ margins of adjustment.
• For instance, positive long-run inflation pushes job creation closer to the efficient level by
eroding markups and reducing worker bargaining power in the presence of sticky wages.
• Market reform reduces the need for inflation to accomplish this.
• Similarly, the reallocation of market share that is implied by trade integration results in an
endogenous increase in average firm productivity.
• This makes job matches more valuable and pushes employment toward the efficient level,
reducing the need for average inflation to accomplish this.
• The incentive to use inflation over the business cycle is similarly determined by the tradeoffs
across domestic and international distortions (which imply more active optimal monetary
policy in the relatively more distorted economy).
18
CALIBRATION
Risk Aversion
 = 1
Frisch Elasticity
1  = 04
Discount Factor
 = 099
Elasticity Matching Function
 = 04
Flexible-Wage Firm Bargaining Power
 = 04
Unemployment Benefit
 = 021
Exogenous Worker Separation
 = 010
Vacancy Cost
 = 010
Matching Efficiency
 = 073
Elasticity of Substitution
 =  = 38
Plant Exit
 = 0026
Pareto Shape
 = 34
Pareto Support
min = 1
Sunk Entry Cost
 = 057
Fixed Export Costs
 = 0005
Iceberg Trade Costs
 = 188
Wage Adjustment Cost
 = 80
Price Adjustment Cost
 = 80
Bond Adjustment Cost
 = 00025
Historical Policy, Interest Rate Smoothing
 = 071
Historical Policy, Inflation
 = 162
Historical Policy, GDP Gap
 = 034
Productivity Persistence
Φ11 = Φ22 = 0999
Productivity Spillover
Φ12 = Φ21 = 0
Productivity Innovations, Standard Deviation
00068
Productivity Innovations, Correlation
0253
31
BUSINESS CYCLE STATISTICS
Variable
     


   )
(

1st Autocorr.

1
1
0.83
0.74
1
1

0.64
0.88
0.70
0.72
0.67
0.95

3.20
5.34
0.89
0.73
0.87
0.60

6.40
6.40
0.88
0.76
-0.86
-0.70

0.52
0.66
0.91
0.93
0.56
0.80

3.18
2.33
0.67
0.67
0.18
0.23

2.54
2.18
0.32
0.66
0.70
0.77
  
0.14
0.36
0.43
0.70
-0.47
-0.31
∗ )
(  
0.44
0.12
∗ )
(  
0.51
0.53
Bold fonts denote U.S. data moments, normal fonts denote model-generated moments.
TABLE 3. WELFARE EFFECTS OF REFORMS, NON STOCHASTIC STEADY STATE
Market Reform
∆Welfare (Historical)
∆Welfare (Peg)
∆Welfare (Ramsey)
Ramsey Inflation
Home
Foreign
Home
Foreign
Home
Foreign
Home
Foreign
0%
0%
0%
0%
0.61%
0.61%
2.13%
1.57%
PMR
3.48%
0.025%
3.48%
0.24%
4.01%
0.36%
2.06%
1.57%
LMR
4.29%
0.084%
4.27%
0.084%
4.59%
0.36%
1.59%
1.59%
JOINT
7.09%
0.10%
6.98%
0.09%
7.34%
0.78%
1.57%
1.57%
Status Quo
(Flexible Foreign)
Note: PMR
JOINT
≡ Product Market Reform; LMR ≡ Labor Market Reform;
≡ Product and Labor Market Reform;
∆Welfare (Historical) ≡ Welfare change under historical policy;
∆Welfare (Peg) ≡ Welfare change under peg (Foreign leader);
∆Welfare (Ramsey) ≡ Welfare change under Ramsey policy.
32
H om e C ons um pt ion
H om e G D P
H om e U nem ploy m ent
H om e E nt ry
0
5
0
5
4
4
3
3
-4
-6
-2
2
2
-2
-1
-8
1
5
10
15
20
25
30
35
5
10
F oreign C ons um pt ion
15
20
25
30
35
5
10
F oreign G D P
3. 5
15
20
25
30
35
10
0
3. 5
3
15
20
25
35
30
35
30
35
-2
-0. 5
-4
2. 5
2
1. 5
-1
2
5
10
15
20
25
30
35
5
H om e W age I nf lat ion
10
15
20
25
30
35
-6
5
10
H om e P roduc er P ric e I nf lat ion
1
15
20
25
30
35
5
10
N om inal E x c hange R at e
1
15
20
25
T erm s of T rade
1. 5
0
1
0. 5
0. 5
0
0
10
30
F oreign E nt ry
3
2. 5
5
F oreign U nem ploy m ent
5
10
15
20
25
30
35
0
5
F oreign W age I nf lat ion
10
15
20
25
30
35
0. 8
0. 6
0. 6
0. 4
0. 4
0. 2
0. 2
0
15
20
25
30
10
35
5
10
H om e E x port s
100
80
80
60
60
40
40
20
25
15
20
25
30
30
35
5
10
R eal E x c hange R at e
35
20
25
R am s ey
0. 1
0
-0. 1
-0. 2
5
10
15
20
25
30
35
5
10
H om e E x port ers
20
15
H om e C urrent A c c ount
H is t oric al
H om e I m port s
100
15
0. 6
0. 4
0. 2
0
-0. 2
-0. 4
0
10
-1
5
F oreign P roduc er P ric e I nf lat ion
0. 8
5
-0. 5
0. 5
15
20
25
30
35
30
35
F oreign E x port ers
80
80
60
60
40
40
20
20
0
5
10
15
20
25
30
35
5
10
15
20
25
30
35
5
10
15
20
25
30
35
5
Trade Integration, Asymmetric Countries, Historical Policy (Solid) versus Optimal Policy (Dashed).
10
15
20
25
H om e C ons um pt ion
H om e G D P
H om e U nem ploy m ent
H om e E nt ry
0
2
0
-2
-4
-6
-8
2
0
-2
5
10
15
20
25
30
35
30
-2
20
-4
5
10
F oreign C ons um pt ion
15
20
25
30
35
10
5
10
F oreign G D P
2
15
20
25
30
35
5
10
F oreign U nem ploy m ent
0
25
30
35
30
35
30
35
0
-1
2
20
F oreign E nt ry
0
4
15
-10
-2
-2
0
5
10
15
20
25
30
35
-20
5
H om e W age I nf lat ion
10
15
20
25
30
35
5
10
H om e P roduc er P ric e I nf lat ion
1. 4
1. 2
1
0. 8
0. 6
0. 4
0. 2
15
20
25
30
35
11
20
25
30
35
10
15
20
25
30
35
0. 8
0. 6
0. 4
0. 2
10
15
20
25
30
0
5
10
F oreign P roduc er P ric e I nf lat ion
35
15
20
25
30
35
5
10
R eal E x c hange R at e
15
20
25
H om e C urrent A c c ount
0
1. 2
1
0. 8
0. 6
0. 4
0. 2
5
2
-4
5
F oreign W age I nf lat ion
1
25
-2
0
15
20
4
2
0. 5
15
T erm s of T rade
0
10
10
N om inal E x c hange R at e
1
5
5
H is t oric al
0
-0. 5
R am s ey
-1
-1
-1. 5
-2
5
10
H om e E x port s
15
20
25
30
35
5
10
H om e I m port s
15
20
25
30
35
5
10
H om e E x port ers
15
20
25
30
35
30
35
F oreign E x port ers
0
0
10
10
-5
-5
5
5
-10
-10
0
5
10
15
20
25
30
35
0
5
10
15
20
25
30
35
5
10
15
20
25
30
35
5
10
15
20
25
Home Product Market Deregulation, Flexible Regulation in Foreign, High Trade, Historical Policy (Solid) versus Optimal Policy
(Dashed).
H om e C ons um pt ion
H om e G D P
H om e U nem ploy m ent
H om e E nt ry
0
5
4
-2
2
-4
0
-6
10
0
4
3
2
5
10
15
20
25
30
35
-10
-20
5
10
F oreign C ons um pt ion
15
20
25
30
35
5
10
F oreign G D P
20
25
30
35
5
10
F oreign U nem ploy m ent
15
20
25
30
35
30
35
30
35
F oreign E nt ry
0
2. 5
2
15
0
2
1
1. 5
-1
-5
-2
-10
1
0
0. 5
-1
5
10
15
20
25
30
35
5
H om e W age I nf lat ion
10
15
20
25
30
35
5
10
H om e P roduc er P ric e I nf lat ion
15
20
25
30
35
5
10
N om inal E x c hange R at e
15
20
25
T erm s of T rade
0. 5
1
1
1
0
0. 5
0. 5
0. 5
-0. 5
12
0
5
10
15
20
25
30
35
-0. 5
0
0
5
F oreign W age I nf lat ion
10
15
20
25
30
35
5
10
F oreign P roduc er P ric e I nf lat ion
1
0. 6
1
0. 8
0. 6
0. 4
0. 4
0. 2
0. 2
0. 8
15
20
25
30
35
10
15
20
25
30
35
R am s ey
-0. 4
5
10
15
20
25
30
35
-0. 6
5
10
H om e I m port s
15
20
25
30
35
20
25
30
35
30
35
F oreign E x port ers
6
4
0
2
2
35
15
2
4
30
10
8
4
6
2
25
5
H om e E x port ers
8
20
-0. 2
0
4
15
25
H om e C urrent A c c ount
6
10
20
H is t oric al
0. 2
H om e E x port s
5
15
0
0. 4
6
0
10
R eal E x c hange R at e
0. 6
-0. 2
5
5
5
10
15
20
25
30
35
5
10
15
20
25
30
35
5
10
15
20
25
Home Labor Market Deregulation, Flexible Regulation in Foreign, High Trade, Historical Policy (Solid) versus Optimal Policy
(Dashed).
H om e C ons um pt ion
H om e G D P
H om e U nem ploy m ent
H om e E nt ry
0
6
30
5
-2
4
20
0
-4
2
10
-6
-5
5
10
15
20
25
30
35
5
10
F oreign C ons um pt ion
15
20
25
30
35
5
10
F oreign G D P
15
20
25
30
35
10
15
20
25
35
30
35
30
35
0
3
0
2
-1
1
-1
5
10
15
20
25
30
35
-10
-2
0
-2
-20
5
H om e W age I nf lat ion
10
15
20
25
30
35
5
10
H om e P roduc er P ric e I nf lat ion
15
20
25
30
35
5
10
N om inal E x c hange R at e
15
20
25
T erm s of T rade
3
1
1
1
2
0
0. 5
0. 5
0
0
1
-1
0
-2
13
30
F oreign E nt ry
0
1
5
F oreign U nem ploy m ent
5
10
15
20
25
30
35
5
F oreign W age I nf lat ion
10
15
20
25
30
35
0. 8
0. 6
0. 4
0. 2
10
15
20
25
30
5
10
F oreign P roduc er P ric e I nf lat ion
35
10
30
35
5
10
15
20
25
H om e C urrent A c c ount
0
H is t oric al
R am s ey
-0. 5
-1
-1
10
15
20
25
30
35
-1. 5
5
10
H om e I m port s
0
25
0
H om e E x port s
15
20
1
5
5
15
R eal E x c hange R at e
1. 2
1
0. 8
0. 6
0. 4
0. 2
1
5
-1
15
20
25
30
35
5
10
H om e E x port ers
15
20
25
30
35
30
35
F oreign E x port ers
15
0
10
-2
-4
5
5
-5
5
10
15
20
25
30
35
-6
5
10
15
20
25
30
35
5
10
15
20
25
30
35
5
10
15
20
25
Home Product and Labor Market Deregulation, Flexible Regulation in Foreign, High Trade, Historical Policy (Solid) versus
Optimal Policy (Dashed).
WELFARE EFFECTS OF REFORMS, STEADY STATE, HIGH TRADE
Market Reform
Welfare (Historical)
Welfare (Peg)
Welfare (Ramsey)
Ramsey In‡ation
Home
Foreign
Home
Foreign
Home
Foreign
Home
Foreign
0%
0%
0%
0%
0.53%
0.27%
2.07%
1.55%
Asymmetric PMR
3.41%
0.08%
3.41%
0.08%
3.89%
0.35%
2.01%
1.54%
Asymmetric LMR
3.95%
0.23%
3.94%
0.23%
4.22%
0.48%
1.55%
1.53%
Asymmetric JOINT
6.64%
0.28%
6.64%
0.28%
6.91%
0.52%
1.52%
1.52%
Status Quo
(Flexible Partner)
Note: PMR
JOINT
Product Market Reform; LMR
Labor Market Reform;
Product and Labor Market Reform; Asymmetric
Welfare (Historical)
Welfare (Peg)
Home country reform;
Welfare change under historical policy;
Welfare change under exchange rate peg (Foreign leader);
Welfare (Ramsey)
Welfare change under Ramsey policy.
11
WELFARE EFFECTS OF REFORMS, BUSINESS CYCLE, HIGH TRADE
Market Reform
Welfare Cost (Historical)
Welfare Cost (Peg)
Home
Foreign
Home
Foreign
Home
Foreign
2.37%
1.15%
2.42
1.15
2.033%
0.92%
Asymmetric PMR
1.95%
1.12%
1.98%
1.12%
1.62%
0.89%
Asymmetric LMR
1.10%
1.07%
1.14%
1.07%
0.87%
0.85%
Asymmetric JOINT
1.08%
1.06%
1.12%
1.06%
0.85%
0.85%
Status Quo
Welfare Cost (Ramsey)
(Flexible Partner)
Note: PMR
JOINT
Product Market Reform; LMR
Labor Market Reform;
Product and Labor Market Reform; Asymmetric
Welfare Cost (Historical)
Welfare Cost (Peg)
Home country reform;
Welfare cost of business cycles under historical policy;
Welfare cost of business cycles under exchange rate peg (Foreign
leader);
Welfare Cost (Ramsey)
Welfare cost of business cycles under Ramsey policy.
12
H om e C ons um pt ion
H om e G D P
H om e U nem ploy m ent
5
5
0
4
4
-1
3
3
2
2
H om e E nt ry
0
-5
-2
-10
5
10
15
20
25
30
35
5
10
F oreign C ons um pt ion
15
20
25
30
35
5
10
F oreign G D P
15
20
25
30
35
5
10
F oreign U nem ploy m ent
5
5
0
4
4
-1
3
3
15
20
25
30
35
30
35
30
35
F oreign E nt ry
0
-5
-2
2
2
-10
5
10
15
20
25
30
35
5
H om e W age I nf lat ion
10
15
20
25
30
35
5
10
H om e P roduc er P ric e I nf lat ion
1
15
20
25
30
35
5
10
N om inal E x c hange R at e
15
20
25
T erm s of T rade
1
1
0
0
1
0. 5
0. 5
0
0
9
5
10
15
20
25
30
35
-1
5
F oreign W age I nf lat ion
10
15
20
25
30
35
-1
5
10
F oreign P roduc er P ric e I nf lat ion
15
20
25
30
35
10
15
20
25
30
35
-1
5
10
H om e E x port s
35
-1
5
10
30
35
15
20
25
30
35
5
60
40
40
40
20
10
15
20
25
30
35
15
20
25
30
35
30
35
F oreign E x port ers
60
5
10
H om e E x port ers
80
40
25
30
60
60
20
25
80
80
15
20
100
80
25
0
100
100
10
15
H om e I m port s
100
5
R am s ey
0
0
5
20
H is t oric al
0. 5
0
15
1
1
0. 5
10
H om e C urrent A c c ount
1
1
5
R eal E x c hange R at e
20
5
10
15
20
25
30
35
5
10
15
20
25
Trade Integration, Symmetric Flexible Countries, Historical Policy (Solid) versus Optimal Policy (Dashed).
TABLE 4: CALIBRATION
Parameter
Risk Aversion
C
1=
Frisch elasticity
=1
h
= 0:4
= 0:99
Discount Factor
Source/Target
Literature
Literature
r = 4%
" = 0:4
Literature
= 0:4
Literature
b = 0:54
Literature
Exogenous separation
= 0:10
Literature
Vacancy Cost
= 0:16
s = 60%
Matching E¢ ciency
= 0:68
q = 70%
Elasticity of Substitution
= 3:8
Literature
Plant Exit
= 0:026
JDEXIT
JD
Elasticity Matching Function
Firm Bargaining Power
Home Production
= 40%
Pareto Shape
kp = 3:4
Literature
Pareto Support
zmin = 1
Literature
Sunk Entry Cost
fe = 0:69
Literature
Fixed Export Costs
fx = 0:005
(Nx =N ) = 21%
Iceberg Trade Costs
= 1:75
(I + X) =Y = 10%
= 0:56
Rotemberg Wage Adj. Cost
# = 60
Rotemberg Price Adj. Cost
= 80
Literature
Taylor - Interest Rate Smoothing
%i = 0:71
Literature
Taylor - In‡ation Parameter
% = 1:62
Literature
Taylor - Output Gap Parameter
%Y = 0:34
Literature
= 0:0025
Bond Adjustment Cost
l
YR
Literature
TABLE 5: TRADE INTEGRATION – NON STOCHASTIC STEADY STATE
Ramsey Gain
Ramsey In‡ation
T rade
GDP =
0:1
0:34%
1:40%
T rade
GDP =
0:2
0:22%
1:20%
T rade
GDP =
0:35
0:16%
1:05%
42
TABLE 6: TRADE INTEGRATION – NON STOCHASTIC STEADY STATE
Relative Gain from Coordination — PCP
Optimal Rule
Historical Rule
Peg
Nash
Leader
Follower
T rade
GDP =
0:1
0.88%
18.62%
18.81%
43.45%
0.0001%
T rade
GDP =
0:2
3.13%
25.36%
26.90%
45.40%
0.001%
T rade
GDP =
0:35
3.15%
29.69%
32.31%
48.39%
0.09%
Relative Gain from Coordination — LCP
Optimal Rule
Historical Rule
Peg
Nash
Leader
Follower
T rade
GDP =
0:1
2.17%
20.91%
20.89%
44.90%
0.10%
T rade
GDP =
0:2
2.66%
29.09%
29.49%
47.34%
0.90%
T rade
GDP =
0:35
3.16%
36.16%
37.00%
51.97%
2.42%
Note: gains are the percentage reduction in welfare costs of business cycle under the Ramsey-optimal policy.
TABLE 7: TRADE INTEGRATION AND GDP COMOVEMENT
corr(YR;t ; YR;t )— Producer Currency Price
T rade
GDP =
0:1
T rade
GDP =
0:2
T rade
GDP =
0:35
Historical Rule
0.36
0.45
0.49
Peg
0.05
0.19
0.27
Ramsey
0.07
0.29
0.43
Nash
0.28
0.35
0.48
corr(YR;t ; YR;t )— Local Currency Price
T rade
GDP =
0:1
T rade
GDP =
0:2
T rade
GDP =
0:35
Historical Rule
0.33
0.42
0.47
Peg
0.05
0.20
0.27
Ramsey
0.36
0.53
0.62
Nash
0.28
0.36
0.42
43
TABLE 6: TRADE INTEGRATION – NON STOCHASTIC STEADY STATE
Relative Gain from Coordination — PCP
Optimal Rule
Historical Rule
Peg
Nash
Leader
Follower
T rade
GDP =
0:1
0.88%
18.62%
18.81%
43.45%
0.0001%
T rade
GDP =
0:2
3.13%
25.36%
26.90%
45.40%
0.001%
T rade
GDP =
0:35
3.15%
29.69%
32.31%
48.39%
0.09%
Relative Gain from Coordination — LCP
Optimal Rule
Historical Rule
Peg
Nash
Leader
Follower
T rade
GDP =
0:1
2.17%
20.91%
20.89%
44.90%
0.10%
T rade
GDP =
0:2
2.66%
29.09%
29.49%
47.34%
0.90%
T rade
GDP =
0:35
3.16%
36.16%
37.00%
51.97%
2.42%
Note: gains are the percentage reduction in welfare costs of business cycle under the Ramsey-optimal policy.
TABLE 7: TRADE INTEGRATION AND GDP COMOVEMENT
corr(YR;t ; YR;t )— Producer Currency Price
T rade
GDP =
0:1
T rade
GDP =
0:2
T rade
GDP =
0:35
Historical Rule
0.36
0.45
0.49
Peg
0.05
0.19
0.27
Ramsey
0.07
0.29
0.43
Nash
0.28
0.35
0.48
corr(YR;t ; YR;t )— Local Currency Price
T rade
GDP =
0:1
T rade
GDP =
0:2
T rade
GDP =
0:35
Historical Rule
0.33
0.42
0.47
Peg
0.05
0.20
0.27
Ramsey
0.36
0.53
0.62
Nash
0.28
0.36
0.42
43
Conclusions
• Changes in economic structure implied by market reforms and trade integration have
important implications for the macroeconomy and monetary policy.
• There are sizable gains for trade partners from the implementation of optimal, cooperative
policies relative to historical behavior.
• The benefits of market reforms in the Euro Area will be maximized, domestically and abroad,
if policies are adjusted cooperatively to the new environment in which they operate.
19
H om e C ons um pt ion
H om e G D P
H om e U nem ploy m ent
H om e E nt ry
0
4
0. 6
0. 6
0. 4
0. 4
0. 2
0. 2
-0. 2
2
-0. 4
-0. 6
10
20
30
40
50
60
70
80
10
20
F oreign C ons um pt ion
30
40
50
60
70
80
0
10
20
F oreign G D P
0. 25
40
50
60
70
80
10
20
F oreign U nem ploy m ent
30
40
50
60
70
80
60
70
80
60
70
80
60
70
80
60
70
80
F oreign E nt ry
0
0. 2
0. 8
0. 2
-0. 05
0. 15
0. 15
30
0. 6
0. 4
0. 1
0. 05
10
20
30
40
50
60
70
0. 1
-0. 1
0. 05
-0. 15
80
10
H om e W age I nf lat ion
20
30
40
50
60
70
80
0. 2
0
10
20
H om e P roduc er P ric e I nf lat ion
0. 1
40
50
60
70
80
20
N om inal E x c hange R at e
30
40
50
T erm s of T rade
0
-0. 02
-0. 1
-0. 1
-0. 04
0
10
0
0
0. 05
30
-0. 2
-0. 2
10
20
30
40
50
60
70
80
10
-3
F oreign W age I nf lat ion
x 10
20
30
40
50
60
70
80
10
20
F oreign P roduc er P ric e I nf lat ion
30
40
50
60
70
80
10
20
30
40
50
60
70
0. 01
-10
0. 05
0
-15
0
-0. 01
80
10
20
H om e E x port s
30
40
50
60
70
80
10
20
H om e I m port s
1
50
0. 02
0. 1
-0. 01
40
H om e C urrent A c c ount
H is t oric al
-5
0. 01
30
0. 03
0. 15
0
20
R eal E x c hange R at e
0. 03
0. 02
10
30
40
50
60
70
80
10
20
H om e E x port ers
30
40
50
F oreign E x port ers
0. 8
0. 5
0
0. 6
0. 6
0. 6
0. 4
0. 4
0. 4
0. 2
0. 2
0
0
0. 2
0
-0. 2
10
20
30
40
50
60
70
80
10
20
30
40
50
60
70
80
10
20
30
40
Home Productivity Shock, Flexible Regulation, Historical Policy.
50
60
70
80
10
20
30
40
50
TABLE 4: CALIBRATION
Parameter
Risk Aversion
C
1=
Frisch elasticity
=1
h
= 0:4
= 0:99
Discount Factor
Source/Target
Literature
Literature
r = 4%
" = 0:4
Literature
= 0:4
Literature
b = 0:54
Literature
Exogenous separation
= 0:10
Literature
Vacancy Cost
= 0:16
s = 60%
Matching E¢ ciency
= 0:68
q = 70%
Elasticity of Substitution
= 3:8
Literature
Plant Exit
= 0:026
JDEXIT
JD
Elasticity Matching Function
Firm Bargaining Power
Home Production
= 40%
Pareto Shape
kp = 3:4
Literature
Pareto Support
zmin = 1
Literature
Sunk Entry Cost
fe = 0:69
Literature
Fixed Export Costs
fx = 0:005
(Nx =N ) = 21%
Iceberg Trade Costs
= 1:75
(I + X) =Y = 10%
= 0:56
Rotemberg Wage Adj. Cost
# = 60
Rotemberg Price Adj. Cost
= 80
Literature
Taylor - Interest Rate Smoothing
%i = 0:71
Literature
Taylor - In‡ation Parameter
% = 1:62
Literature
Taylor - Output Gap Parameter
%Y = 0:34
Literature
= 0:0025
Bond Adjustment Cost
l
YR
Literature
TABLE 5: TRADE INTEGRATION – NON STOCHASTIC STEADY STATE
Ramsey Gain
Ramsey In‡ation
T rade
GDP =
0:1
0:34%
1:40%
T rade
GDP =
0:2
0:22%
1:20%
T rade
GDP =
0:35
0:16%
1:05%
42