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An Open Economy Model of the Euro Area and the US

  • Economics


An Open Economy Model of the Euro Area and the US AN OPEN ECONOMY MODEL OF THE EURO AREA AND THE US* Sandra Gomes** João Sousa** 1. INTRODUCTION In this article we present the medium sized open-economy Dynamic Stochastic General Equilibrium (DSGE) model of the euro area and the US developed by Alves, Gomes and Sousa (2007). We take stock of recent developments of the so-called New Open Economy Macroeconomics. Therefore the model presented here shares a number of common features with models developed at other policy in- stitutions (like the Global Economy Model (GEM) at the International Monetary Fund) as well as other central banks (for instance, with the New Area Wide Model at the European Central Bank). The main purpose of the model is to provide a theoretically consistent representation of the behaviour of the euro area economy. Such model can then be used to study how various shocks are transmitted to the key euro area macroeconomic variables. Currently the model is calibrated drawing on the results of similar studies. At a later stage, an estimated version of the model will allow the identification of structural shocks which can be an important input for monetary policy analysis. A major advantage of the model presented here relative to traditional models is that it is derived from strong theoretical micro foundations. As such, it is likely to be less prone to stability problems such as those pointed out in Lucas’s famous critique (see Lucas, 1976). These type of models have been gaining increasing popu- larity, both in the academia and in policy making institutions, as they are much more in line with current academic thinking than traditional macroeconometric models while at the same time displaying desireable empirical properties. A disadvantage of these models is that they cannot be of such a large scale as that of traditional macro models given problems of tractability. The model presented here reflects such simplification. A distinguis

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