Master Thesis - Humboldt-Universität zu Berlin

Preference shocks, inflation objective shocks, and labor supply shocks are excluded
from the model. The main difference with respect to the intermediate
production sector comes from the input of oil and non-oil inputs in the production
function. In addition, distortional taxes on labor income, individual
consumption, and capital earnings are taxed by the government to finance
its own consumption; a part of the tax revenues return to the households as
lump-sum transfers. A level of economic openness is achieved by integrating
both models through international trade in goods and assets. The imperfect
international capital market is stochastically represented, which helps to explain
the departure from the uncovered rate parity condition and high short
time volatility of exchange rate. The incomplete pass-through in the model
originates only from nominal price rigidities. Current account is determined
by an inter-temporal budget constraint, a typical assumption in the NOEM
models. The set of variables and shocks is extended in order to express the
net-trade flows, the import and consumption price inflation, the rate of depreciation
and the oil price fluctuations.
In the present paper, we keep the initial specification of the open economy
relatively simple. Richer models that explain the depreciation rate evolution
address endogenously determined risk premiums on foreign currency associated
with net foreign assets holdings i.e. Bergin (2005), Adolfson, Laséen,
Lindé, and Villani (2005); or with monetary policy actions i.e. Obstfeld and
Rogoff (2002). Bergin (2005) investigates the importance of producer currency
pricing for exporters (pricing to market) and finds that this assumption
is supported by the data.
The home bias helps to explain elasticity of substitution between domestic
and foreign goods. In this setup the authors follow Corsetti et al. (2003) to
determine the value of the elasticity of substitution via an estimated share
of imports in the domestic service sector. Through the elasticity of substitution
and relative domestic and foreign prices, the cost minimization objective
function of the representative agent determines the proportions of various
goods in the final product.
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