Bank of Lithuania
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2019-01-15

No 57. Michael Donadelli, Patrick Grüning, Aurelija Proškutė. Monetary policy, trade, and endogenous growth under different international financial market structures

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This study develops a symmetric two-country New-Keynesian general equilibrium model with endogenous growth, Calvo-style price and wage rigidities, and international trade of final consumption goods and intermediate goods. The equilibrium implications of two financial market structures are compared: financial autarky and complete markets. In the case of financial autarky, no international bond is traded. In the case of complete markets, the households have access to a full set of international nominal state-contingent bonds. We find that assuming complete markets instead of financial autarky leads to higher co-movement of most macroeconomic growth rates across countries, higher co-movement of inflation rates across countries, lower uncovered interest rate parity regression coefficients, and a lower correlation between exchange rate growth and consumption growth differentials. These results are mostly in line with US and UK data from 1950-2015, which are split into two samples, 1950-1970 and 1971-2015, in order to be compared to the model with financial autarky and the model with complete markets, respectively.

JEL Codes: E30, E44, F44, G12, O30.

The views expressed are those of the author(s) and do not necessarily represent those of the Bank of Lithuania.

Michael Donadelli, Patrick Grüning, Aurelija Proškutė, International financial markets, Monetary policy, Nominal rigidities, Endogenous growth