Macroeconomic Interdependence in a
Two-Country DSGE Model under Diverging
Interest-Rate Rules
Ulrich Gunter
Department of Economics, University of Vienna
Hohenstaufengasse 9, A-1010 Vienna, Austria1
Email: [email protected]
Phone: +43 4277 37453
April 22, 2009
Abstract: The present article extends a variant of the Obstfeld/Rogoff (2001) two-country DSGE
model by introducing Calvo (1983) pricing. It is possible to collapse the model into a canonical log-
linear representation consisting of two dynamic IS and two New Keynesian Phillips curves. Reflecting
the differing statutes of the ECB and the Fed, two diverging interest-rate rules are introduced. For
a sensible calibration of the model we can derive a locally unique rational expectations equilibrium.
Furthermore, we find that aggregate productivity shocks, which are assumed to be positively correlated
across countries, have a negative impact on domestic and foreign output, a phenomenon already described
for the closed economy by Gall (2002). Cost-push as well as contractionary monetary policy shocks,
which are assumed to be country-specific, also have a negative impact on domestic and foreign output since
the economies are interdependent due to terms-of-trade externalities. Contrary to Corsetti/Pesenti
(2001), expansionary monetary policy shocks always have a ”prosper thyself” and ”beggar thy neighbor”
effect since they influence the terms of trade beneficially for the respective country’s resident households.
Finally, if the ECB implemented the interest-rate rule proposed in the present article, it would encounter
lower fluctuations in European producer price inflation compared to an interest-rate rule as proposed
for the Fed. This is consistent with the ECB’s paramount objective of price stability. However, this
advantage only holds at the expense of relatively high fluctuations in the European output gap.
Keywords: two-country DSGE model, diverging interest-rate rules, equilibrium determinacy, calibra-
tion, impulse-response analysis.
JEL classification codes: E12 E52 E58 F41 F42 F47
1 I would like to thank Gerhard Sorger and Lutz Weinke for their support and fruitful discussions.