Master Thesis - Humboldt-Universität zu Berlin

Like non-oil imports, oil intervenes both in the final good production and
the intermediary domestic good production process. The demand for oil is
assumed to be proportional to total demand and total production of domestically
produced intermediate good: no substitution effects are allowed.
O t = O p t + O f t (21)
The oil price together with the non-oil import price feed immediately into the
final good price without any rigidity, while both prices affect the domestic
output price gradually through the marginal production cost and the Calvo
price setting assumption.
The link of the external sector with the world economy is made by expressing
the imports as weighted exports of the US and rest of the world economies,
and in the opposite direction deriving exports as foreign imports among the
same parties, with β m the share of imports and β x the share of exports of
US economy from and to domestic economy:
M t = β m X ∗ t + (1 − β m )X ROW ∗
t (22)
X ROW ∗
t
will be used at a later stage to determine the marginal cost of importing
firms and their impact on imported inflation modelled subsequently
in the paper.
X t = β x M ∗ t + (1 − β x )M ROW ∗
t (23)
Since the imports of the Rest of the World Mt
ROW ∗ are not observed and do
not enter the model, we treat them as a demand shock affecting the exports
of the economy: Mt
ROW ∗
Normal error term.
= ɛ NT ∗
t
= ρ NT ∗ ɛ NT ∗
t−1
16
+ ηt
NT ∗ , with ηt NT ∗ an i.i.d. -