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| March 2000 Number 100 |
| JEL classification: C51, F41 |
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Author: Fabio Ghironi I develop a model that improves upon the recent literature in open economy macroeconomics in that it lends itself more directly to empirical investigation. I solve the stationarity problem that characterizes many existing models by adopting an overlapping generations structure àla Weil (1989). I model nominal rigidity by assuming that firms face explicit costs of output price inflation volatility. The specification generates an endogenous markup that fluctuates over the business cycle. I identify the two economies in my model with Canada—a small open economy—and the United States—taken as an approximation of the rest-of-the-world economy. In the second part of the paper, I present a plausible strategy for estimating the structural parameters of the Canadian economy. I do so by using nonlinear least squares at the single-equation level. Estimates of most parameters are characterized by small standard errors and are in line with the findings of other studies. I also develop a plausible way of constructing measures for nonobservable variables. To verify if multiple-equation regressions yield significantly different estimates, I run full information maximum likelihood, system-wide regressions. The results of the two procedures are similar. Finally, I illustrate a practical application of the model, showing how a shock to the U.S. economy is transmitted to Canada under an inflation-targeting monetary regime. |
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48 pages / 306 kb
