Author: Ashima Goyal and Abhishek Kumar
Title: Asymmetry, Terms of Trade and the Aggregate Supply Curve in an Open Economy Model
Abstract: We find a basic new Keynesian monetary policy DSGE model estimated for differing countries (India and the US) gives deep parameter estimates, impulse responses and forecast error variance decompositions for each in line with theory and country structure, implying similar functional forms can be estimated for different countries with estimated coefficients capturing differences in structure. Features that create excess volatility, especially in emerging markets, explain differences in policy shocks. The feature explored in this paper is external terms of trade. When this is dampened in the emerging market, using policy tools other than the policy rate, the aggregate supply curve, which was relatively steeper, becomes flatter. As a result, volatility of interest rates and their impact on output and inflation, which was relatively higher in India, becomes lower than in the US. Asymmetries between the countries are reversed. The estimated coefficient of the terms of trade is relatively higher in the US Taylor rule. It follows emerging market central banks need policy tools in addition to interest rates to affect volatility creating variables like external terms of trade.
Keywords: DSGE; India; US; Asymmetry; Open Economy Model; Terms of Trade; Aggregate Supply Curve
JEL Code: E32; F41; F44