Financial Market Integration and Business Cycle Volatility in a Monetary Union

Transcription

1 Kel Inue of World Economc Dueernbrooker Weg Kel (Germany) Kel Workng Paper No. 5 Fnancal Marke Inegraon and Bune Cycle Volaly n a Moneary Unon by Chran Perdzoch July 2002 The reponbly for he conen of he workng paper re wh he auhor no he Inue. Snce workng paper are of a prelmnary naure may be ueful o conac he auhor of a parcular workng paper abou reul or cavea before referrng o or quong a paper. Any commen on workng paper hould be en drecly o he auhor.

2 Fnancal Marke Inegraon and Bune Cycle Volaly n a Moneary Unon Abrac Th paper ue a dynamc general equlbrum wo-counry opmzng ckyprce model o analyze he conequence of nernaonal fnancal marke negraon for he propagaon of aymmerc producvy hock n a moneary unon. The model mple ha bune cycle volaly hgher he more negraed he capal marke of he member counre of he moneary unon are. Keyword: Open Economy Macroeconomc; Moneary unon; Bune cycle Fnancal marke JEL clafcaon: F33 F36 F4 Dr. Chran Perdzoch Kel Inue of World Economc 2400 Kel Germany Telephone: Fax: E-mal: c.perdzoch@fw.un-kel.de I would lke o hank Clauda Buch for mo helpful dcuon and commen on an earler draf. Remanng error and naccurace are olely n my own reponbly.

3 . Inroducon An aumpon ofen made n heorecal analye of he ncdence of hock n a moneary unon ha he fnancal marke of he member counre of he moneary unon are perfecly negraed. 2 Though h aumpon allevae he heorecal analy of he propagaon of hock n a moneary unon clearly a varance wh he emprcal evdence avalable for he European Moneary Unon. The evdence repored n he emprcal leraure ugge ha alhough a number of ep have been aken durng he pa decade o peed up cro-border fnancal ranacon fnancal marke n Europe are no ye perfecly negraed. 3 Neverhele can be expeced ha wh he nroducon of he euro he proce of fnancal marke negraon n Europe wll gan furher momenum (ee e.g. Danhne e al. 2000). I herefore an nereng and mporan queon how h proce could aler he propagaon of hock n he European Moneary Unon. In h paper I ue a ochac dynamc general equlbrum wo-regon model of a moneary unon wh cky-prce and monopolc compeon o addre h queon. Specfcally I explore he mplcaon of he ongong negraon of regonal fnancal marke for he propagaon of aymmerc producvy hock n an oherwe ymmerc moneary unon. The bac rucure of my model mlar o he rucure of he moneary unon model recenly developed by Bengno (200) and Lombardo (2002). The rucure of her model cloely reemble ha of he canoncal new open economy macro (NOEM) model poneered by Obfeld and Rogoff ( ). Becaue NOEM model have become a andard ool for analyzng nernaonal macro ue hey are a naural 2 3 Moneary unon model feaurng mperfec ubuably beween nernaonally raded fnancal ae can be found e.g. n Allen and Kenen (980) and n Maron (985). The exen of cro-border capal mobly n Europe ha been he ubjec of a number of recen emprcal ude. In general he emprcal evdence ndcae ha he degree of fnancal marke negraon n Europe ha ncreaed. Ye he emprcal evdence alo ugge ha he degree of fnancal marke negraon dffer acro fnancal marke egmen. For a furher dcuon ee e.g. Lemmen (998) Bayoum e al. (999) Berger e al. (2000) Ceneno and Mello (999) and he reference ced heren.

4 2 canddae for analyzng he mpac of fnancal marke negraon on he propagaon of hock n a moneary unon. The core feaure of he NOEM model I ue n h paper ha depar from he aumpon made by Bengno (200) and Lombardo (2002) ha he fnancal marke of he member counre of he moneary unon are fully negraed. To buld no her NOEM model he aumpon ha he fnancal marke of he member counre of he moneary unon are mperfecly negraed I ue he approach recenly advanced by Suherland (996) and Senay (998). They have hown how a relavely mple ranacon co echnology for cro-border fnancal ranacon can be ued o exend NOEM model o ncorporae he aumpon of mperfec nernaonal fnancal marke negraon. My NOEM model how ha he negraon of regonal fnancal marke amplfe he oupu effec of aymmerc producvy hock ha bune cycle volaly hgher he more negraed he capal marke of he member counre of a moneary unon are. However he reul of numercal mulaon ndcae ha h effec mgh be quanavely mall f producvy hock are peren. Moreover for a gven degree of fnancal marke negraon bune cycle volaly end o be larger he hgher he ubuably beween good produced n dfferen member counre of he moneary unon. In conra bune cycle volaly end o be lower he more luggh good prce adju o producvy hock. Furher a would have been expeced fnancal marke negraon n he moneary unon lead o a reducon of conumpon volaly becaue houehold can hold beer dverfed porfolo of fnancal ae when fnancal marke are hghly negraed. The remander of he paper organzed a follow. In Secon 2 I lay ou he NOEM model I ue o derve he reul repored n h paper. In Secon 3 I ue mpule repone funcon and numercal mulaon o analyze he mplcaon of fnancal marke negraon for he propagaon of aymmerc producvy hock n a moneary unon. Secon 4 offer ome concludng remark.

5 3 2. The Model The moneary unon made up of wo regon Home H and Foregn F. Each regon populaed by a connuum of nfnely-lved houehold. In addon each regon populaed by a connuum of frm. Each frm produce a dfferenaed produc and ell n a monopolcally compeve good marke. All good produced by Home and Foregn frm are raded beween he regon. The only producon facor needed o produce a dfferenaed produc labor. Frm hre labor n a perfecly compeve labor marke. There no pobly of mgraon acro regon. 2. Houehold Preference and Good Marke Srucure The member counre of he moneary unon are nhabed by a connuum of nfnely-lved houehold on he nerval [ 0]. The houehold on he egmen j [ 0 n) rede n regon H whle he houehold on he egmen j [n] belong o regon F. Home and Foregn houehold have dencal preference. They form raonal expecaon and eek o maxmze he preen value of her expeced lfeme uly defned a: U ( j) E [log( C ( j)) log( M ( j) / P ) N( j) / 2] () 2 where H f j [ 0 n) and F f j [n] 0 0 and E denoe he condonal expecaon operaor. In Eq. () C ( j) denoe a real conumpon ndex N ( j) he houehold labor upply a regon pecfc ochac producvy ndex and M j) / P ( denoe he end-of-perod real money demand where P he aggregae prce ndex n regon defned below.

6 4 The aggregae conumpon ndex ( ) a CES aggregae of an ndex of C j Home conumpon good C and of an ndex of Foregn conumpon good H C : F / H ( / / ( ) / / ( ) ( ( )) ) F n C j ( n) ( C ( j C j (2) ( ) )) where 0 denoe he elacy of ubuon beween he Home and Foregn conumpon ndex. A n Tlle (200) he ndex C H ( ) ( C F ( )) defned a a CES aggregae over a connuum of dfferenaed perhable Home (Foregn) conumpon good conumed by Houehold of counry. Thee good are old by Home and Foregn frm n a monopolcally compeve good marke. The ndce C H ( ) and C F ( ) can be expreed a: j j j j n /( ) H / j ( ) / C ( j) n { c ( h)} dh (3) 0 / ( ) F / j ( ) / C ( j) ( n) { c ( f )} df (4) n where h [ 0 n) denoe Home and f (n] denoe Foregn good ( ) c j z denoe conumpon of good z by houehold j redng n counry and denoe he elacy of ubuon beween conumpon good produced whn he ame counry. The opmal conumpon allocaon gven by (neglecng he houehold ndex from now on): p ( h) / P h P h P C c ( h) / (5)

7 5 p ( f ) / P f P f P C c ( f ) /. (6) Analogou expreon can be derved for he conumpon allocaon of Foregn houehold. In Eq. (5) and (6) p ( h) denoe he prce of he Home good n regon and p ( f ) denoe he prce of he Foregn good n regon. The prce ndex P h ( P f ) defned a he mnmum expendure requred o buy one un of he ndex of Home (Foregn) conumpon good F C ( C ) n H regon. Thee prce ndce are gven by: /( ) n P h n { p ( h)} dh (7) 0 /( ) ( ) n P f n { p ( f )} df. (8) 0 The aggregae prce ndex for regon hen of he form: /( ) n( P ) ( n)( P P (9) h f ) I aume ha here are no ranacon co for ranporng good acro regon and ha frm conder he whole moneary unon a a common marke when eng prce. Wh houehold preference beng he ame n he member counre of he moneary unon hee aumpon mply ha p h) p ( ) H ( F h

8 6 and p H ( f ) p F ( f ). I mmedaely follow ha we alo have P H P F P.e. purchang power pary hold The Srucure of Fnancal Marke Houehold can rade n Home and Foregn nomnal bond. When radng n hee bond houehold have o ake no conderaon ha he naonal fnancal marke of he member counre of he moneary unon are no perfecly negraed. Wherea Home houehold have free acce o he Home fnancal marke hey ncur nermedaon co when underakng poon n he Foregn fnancal marke. Smlarly Foregn houehold can rade n he Foregn fnancal marke whou ncurrng ranacon co bu ncur nermedaon co when radng n he Home fnancal marke. The real nermedaon co underakng poon n he nernaonal fnancal marke are gven by: Z of Z I 0.5 2[( F F ) / P ] (0) where 0 and 2 0 are pove conan F denoe he ock of foregn currency denomnaed ae held by he houehold of regon F he eady ae level of he foregn ae holdng of houehold (aumed o be dencal acro regon) and I denoe he level of real fund houehold redng n regon j ranfer abroad and hu correpond o he rade balance of regon. Boh Z and I are denomnaed n erm of he conumpon aggregaor C. 4 A purchang power pary hold he model render poble o abrac from effec due o he egmenaon of naonal good marke when analyzng he effec of fnancal marke negraon for macroeconomc dynamc n he moneary unon. Ung a andard NOEM model wh flexble exchange rae Senay (998) ha hown ha he effec of fnancal marke negraon on macroeconomc dynamc are largely ndependen of he degree of good marke negraon.

9 7 The fr erm on he rgh-hand de of Eq. (0) reflec convex adjumen co and dencal o he ranacon co echnology ued by Suherland (996). The econd erm on he rgh-hand de of Eq. (0) nroduced o enure ha he foregn ae poon of he member counre of he moneary unon and hu he eady ae around whch he model log-lnearzed aonary (Schm-Grohe and Urbe 200). The aonary of he eady ae wll erve ueful n he ochac mulaon of he model preened n Secon 3. Toal ncome receved by houehold con of he yeld on her holdng of Home and Foregn bond he prof ncome for he ownerhp of frm (.e. dvdend ncome) and he labor ncome. Gven oal ncome houehold deermne her opmal conumpon decde on her preferred Home and Foregn bond holdng and deermne her preferred money holdng. In addon hey receve ranfer from he governmen of he regon n whch hey rede and ncur ranacon co for underakng cro-border ae ranacon. The dynamc of houehold domec bond holdng herefore obey he followng flow budge conran: D ( R D M M w N PC PI PZ PT () ) where D and for he quany of domec nomnal bond held by agen n regon R denoe he nomnal nere rae earned upon holdng he bond ued by regon beween perod and T and for real lump-um ranfer (denomnaed n erm of he conumpon aggregae C ) w he nomnal wage rae earned by he houehold of regon n a perfecly compeve labor marke and denoe he nomnal prof ncome he houehold n regon receve from he frm of ha regon. The dynamc of houehold Foregn bond holdng are gven by: ( (2) F R k ) F P I

10 8 where k ( H F) and k.e. R denoe he nomnal nere rae earned by k he houehold redng n regon for holdng beween perod and a nomnal bond ued by he Foregn regon k. 2.3 Indvdual Maxmzaon The fr-order condon for he houehold neremporal opmzaon problem are: / P (3) C / (4) M E ( ) (5) N w ( (6) R ) E ( ) ( R k ) E ( ) 2 ( F F ) / P ( R ) E ( I ) (7) where denoe he regon-pecfc Lagrange mulpler. Eq. (7) how ha he nermedaon co for underakng cro-border fnancal ranacon ( 0 2 0) mply ha he nere pary condon lnkng he nere rae on Home and Foregn bond nclude erm accounng for he co ncurred when ranferrng fund beween he Home and he Foregn bond marke.

11 9 Elmnang he Lagrange mulpler from Eq. (7) h nere rae pary condon can be hown o be: ( )( I ) ( R k )( EI ) 2( R )( F R F ) / P (8) 2.4 Prce Seng Each prof-maxmzng frm hre labor o produce a dfferenaed good ndexed by z accordng o he producon funcon y ( z) N ( z). The frm nomnal prof are herefore gven by z) p ( z) y ( z) w y ( ). Becaue each ( z frm ha monopoly power on he marke for he dfferenaed good produce rea he prce ( ) charge for produc a a choce varable and eek o p z e he prce of produc o maxmze prof. When eng he prce of produc he frm face he followng demand curve for good n he monopolcally compeve good marke: y ( z) / P ) Q (9) ( z) ( p where Q ( nc ( H ) ( n) C ( F)) he aggregae good demand n he moneary unon. When eng prce frm have o ake no accoun ha hey are ubjec o luggh prce adjumen of he form decrbed n Calvo (983). Accordng o h prce adjumen mechanm each frm ha o ake no accoun when eng prof-maxmzng prce ha here a pove probably 0 ha canno reve prce eng decon made n perod n perod. Frm herefore e he curren prce of her produc ( ) o a o maxmze he p z expeced preen value V ( z) of curren and fuure real prof where perod

12 0 prof are weghed by he probably ha he curren perod prce ) ( z p wll ll be n force n perod. A n Suherland (996) frm maxmze: z p P z R E z V ) / ( ) ( max ) ( (20) where x x d R wh ) /( R d he dcoun facor for perod expeced real prof. Eq. (20) how ha he luggh prce adjumen make each frm prce eng problem dynamc; raher han maxmzng prof perod-by-perod each frm ac o maxmze oal marke value. Ung Eq. (9) n Eq. (20) he prof-maxmzng prce can expreed a: P P Q R E w P P Q R E z p ) )(/ / ( ) )(/ / ( ) ( (2) Wh prce beng perfecly flexble Eq. (2) mple ha frm e he profmaxmzng prce of her produc accordng o he rule w z p )] /( [ ) (.e. he dfference beween he prce and he margnal co of producon gven by he conan mark up ) /(. 2.5 The Governmen Secor Aumng ha egnorage revenue are reurned o he houehold of he regon accordng o ource he budge conran n perod of he governmen of regon gven by: 0 ) ( ) ( ) ( j j j j M j M j T P (22)

13 The upply of oude money n he moneary unon u M gven by: M M ( j) dj (23) u Defnon of Equlbrum and Model Soluon In a ymmerc monopolc compeon equlbrum n he moneary unon oupu conumpon prce nere rae wage rae and bond holdng follow ochac procee uch ha () he labor marke n each counry clear () he opmaly condon for conumpon and ae holdng are afed () he neremporal budge conran for each counry afed (v) he unon-wde demand for oude money equal o he aggregae upply of oude money and (v) he bond marke are n equlbrum. Iner Table abou here. To olve he model I follow Obfeld and Rogoff (995) and Suherland (996) and log-lnearze he model around a ymmerc flexble-prce eady ae n whch he bond holdng of he member counre of he moneary unon are zero. I hen ue numercal mulaon o analyze he propere of he calbraed log-lnearzed model. The calbraon of he model farly andard and gven n Table. Mo of he parameer are a gven n Suherland (996). 3. Fnancal Marke Inegraon and Macroeconomc Volaly n a Moneary Unon In h econ I ue mpule repone funcon and ochac mulaon o analyze how he negraon of he fnancal marke of he member counre of he moneary unon affec he propagaon of aymmerc producvy hock. I

14 2 aume ha he producvy hock meaured n devaon from he eady ae evolve accordng o he followng fr-order auoregreve procee: (24) where [ 0 ] and a ha denoe ha a varable meaured n erm of devaon from he eady ae. I follow Suherland (996) n aumng ha Home (Foregn) h by a pove (negave) un producvy hock.e. H and F are perfecly negavely correlaed. Iner Fgure abou here. Fgure how he repone of a number of key Home varable o a permanen aymmerc producvy hock ( ). The hock mple ha he margnal producvy of Home labor ncreae. Home houehold reac o h permanen change n he labor producvy by decreang her labor upply. In conequence Home oupu and conumpon fall. Becaue Home houehold eek o moohen conumpon neremporally hey reac o he declne n curren conumpon by runnng a curren accoun defc. Th mple ha he Foregn ae poon of he Home counry declne. Becaue he Foregn ae poon aonary he Home counry realze a rade balance urplu n he medum- and longer-run. Furhermore n he medum- and longer-run a nomnal conrac and herefore good prce ar o adju he real exchange rae e apprecae. The real exchange rae defned a: e q F q H wh q j ( ) p j () { H F} (25) j where he aggregae prce ndce q are conruced o a o ummarze he perod nformaon on all he prce e by Home and Foregn frm repecvely. The dynamc of he real exchange rae n he afermah of he

15 3 aymmerc producvy hock reflec ha he aymmerc producvy hock lead o a conracon (expanon) of Home (Foregn) oupu requrng Home good o become more expenve relave o Foregn good. Fgure furher llurae ha he effec of he producvy hock on oupu he larger he more negraed are he fnancal (bond) marke of he member counre of he moneary unon. Hence he negraon of naonal fnancal marke n he moneary unon end o amplfy bune cycle volaly. Ye Fgure ugge ha h effec end o be quanavely mall f producvy hock are permanen.e. f he ochac procee decrbng he dynamc of he Home and Foregn producvy hock have a un roo. If n conra producvy hock are ranory ( 0 ) he negraon of he fnancal marke of he member counre of he moneary unon ha a more gnfcan mpac on macroeconomc dynamc (Fgure 2). Iner Fgure 2 abou here. To fully underand h reul worh analyzng n more deal he channel hrough whch fnancal marke negraon affec macroeconomc dynamc n he moneary unon. If fnancal marke negraon low he ranacon co for underakng cro-border fnancal ranacon are hgh. When ranacon co are hgh more dffcul for houehold o dverfy her ae holdng. Th n urn mple ha he mpac of he producvy hock on conumpon larger and ha he Home (Foregn) curren accoun defc (urplu) oberved n he afermah of uch a hock maller when he naonal fnancal (bond) marke of he member counre of he moneary unon are only mperfecly negraed. A maller curren accoun defc n urn drecly mple ha n a general equlbrum he mpac of he producvy hock on he real exchange rae maller he le negraed naonal fnancal marke are. Becaue he real exchange rae and hence he relave prce of Foregn good n erm of Home good le reponve o producvy hock when fnancal marke are negraed follow ha he mpac of uch a hock on oupu an nvere funcon of he degree of fnancal marke negraon. In conequence oupu

16 4 volaly end o be hgher he hgher he degree of fnancal marke negraon n he moneary unon. To oban furher ngh no he propere of he model I repor n Table 2 he reul of ochac mulaon of he model. Table 2 gve he volale (andard devaon) of Home oupu and conumpon for dfferen degree of fnancal marke negraon n he moneary unon. In addon Table 2 llurae he mplcaon of varyng he degree of elacy of ubuon beween good produced n he dfferen member counre of he moneary unon and of varyng he degree of prce ckyne for oupu and conumpon volaly. Iner Table 2 abou here. Wh repec o he mpac of fnancal marke negraon on bune cycle volaly he reul gven n Table 2 confrm he fndng ummarzed n Fgure and 2. Fnancal marke negraon end o magnfy he mpac of producvy hock on oupu. Hence he more negraed he naonal fnancal marke of he member counre of he moneary unon are he larger bune cycle volaly due o producvy hock n he moneary unon. Conumpon volaly n conra decreae f fnancal marke negrae becaue houehold can beer dverfy her ae holdng when fnancal marke are hghly negraed. Table 2 furher ugge ha bune cycle volaly end o be hgher he larger he elacy of ubuon beween Home and Foregn good and he hgher he degree of prce ckyne. A hgh elacy of ubuon beween Home and Foregn good mple ha a re of he prce of Home good relave o he prce of Foregn good reul n a rong hf of demand oward Foregn good. Increang he elacy of ubuon beween Home and Foregn good herefore mple ha he apprecaon of he real exchange rae rggered by an aymmerc producvy hock nduce houehold o underake a relavely large reallocaon of conumpon pendng n favor of Foregn good. In conequence he oupu and conumpon volaly caued by producvy

17 5 hock are ncreang funcon of he ubuably beween Home and Foregn good. Anoher facor ha affec bune cycle volaly he degree of prce ckyne. A hown n Table 2 he hgher he degree of prce ckyne he lower he volaly of oupu and conumpon. Increang he degree of prce ckyne mple ha ake longer before producvy hock unfold her full mpac on he real exchange rae. Becaue he real exchange rae deermne he prce of Foregn good n erm of Home good he low repone of he real exchange rae mple ha he hor-run oupu effec of a producvy hock end o be an nvere funcon of he degree of prce ckyne. A a fnal exerce I llurae by mean of Fgure 3 he mplcaon of aymmerc producvy hock for eleced mporan unon-wde varable. Specfcally Fgure 3 graph he mpac of an aymmerc producvy hock on he me pah of he unon-wde oupu (.e. he populaon-weghed ome of Home and Foregn oupu) of he unon-wde prce level of he nernaonal nomnal hor-erm nere rae dfferenal and of he Home and Foregn money demand. Becaue Home and Foregn producvy hock are by aumpon perfecly negavely correlaed he mpac of uch an aymmerc producvy hock on unon-wde oupu equal o zero. Smlarly becaue he degree of prce ckyne due of he aumpon of perfec ymmery of he Home and Foregn econome he ame n boh member counre of he moneary unon he aymmerc producvy hock doe no requre a change n he aggregae prce level. Were he degree of prce ckyne n he Home counry dfferen from he degree of prce ckyne n he Foregn counry hen he producvy hock would reul n an adjumen of he unon-wde prce level. Iner Table 2 abou here. Fgure 3 furher llurae ha an aymmerc producvy hock reul n a change of he drbuon of oude money beween Home and Foregn

18 6 houehold. Becaue n he Home counry he nomnal hor-erm nere rae ncreae and conumpon decreae n he afermah of an expanonary producvy hock Home money demand declne. In conra money demand n he Foregn counry ncreae by he ame amoun. The reaon ha becaue of he aymmery of he producvy hock he macroeconomc dynamc n he Foregn counry are a mrror-mage of hoe n he Home counry. Becaue he unon-wde upply of oude money doe no change a long a he cenral bank doe no reac o producvy hock he populaon weghed um of he Home and Foregn demand for oude money exacly equal o zero. 4. Concluon In recen year he o called NOEM model have become a popular way of analyzng macroeconomc dynamc n open econome. In h paper I ued a NOEM model o udy how he negraon of nernaonal fnancal marke affec he whn-counry and cro-counry propagaon of aymmerc producvy hock n a moneary unon conng of wo oherwe ymmerc member counre. The reul of numercal mulaon of he model ndcaed ha he negraon of nernaonal fnancal marke could mply ha he mpac of permanen and ranory producvy hock on oupu ncreae hu leadng o a more pronounced regonal bune cycle n a moneary unon. However mulaon of he calbraed model howed ha h effec mgh be quanavely mall f producvy hock are permanen. I goe whou ayng ha he reul repored n h paper hould no be reched oo far. Before defnve polcy concluon can be reached from he knd of analy underaken n h paper more reearch need o be done. For nance a and he NOEM model developed n h paper decrbed wha happen when he fnancal marke of he member counre of a moneary unon become more negraed. I would be nereng o exend h analy n fuure reearch by udyng how macroeconomc dynamc change when he (pobly negraed) fnancal marke of he member counre of a moneary unon begn negrang no world fnancal marke. Such an analy could yeld mporan leon for emergng marke econome.

19 7 A furher queon no addreed n h paper how moneary and fcal polcy n a moneary unon hould reac o he negraon of fnancal marke. In h repec would be nereng o analyze how he negraon of fnancal marke affec he ranmon of moneary and fcal polcy hock n a moneary unon. When dong uch reearch no only he mplcaon of fnancal marke negraon for bune cycle volaly bu alo he welfare mplcaon of boh fnancal marke negraon and dfferen moneary and fcal polcy raege hould be uded. The model lad ou n h paper could provde a ueful modelng plaform for uch reearch. In h paper I analyzed he mplcaon of fnancal marke negraon for he propagaon of aymmerc producvy hock n an oherwe ymmerc moneary unon. In fuure reearch he NOEM model oulned n h paper could be exended o analyze how he negraon of nernaonal fnancal marke aler he effec of ymmerc hock n an aymmerc moneary unon. For example would be nereng o analyze how he reul documened n h paper are affeced when a ymmerc producvy hock h he member counre of a moneary unon feaurng dfferen prce adjumen parameer or dfferen nraemporal and neremporal conumpon elace.

20 8 Reference Allen P.R. and P.B. Kenen (980) Ae Marke Exchange Rae and Economc Inegraon. Cambrdge: Cambrdge Unvery Pre. Bayoum T. L. Sarno and M.P. Taylor (999) European Capal Flow and Regonal Rk. The Mancheer School 67: Bengno P. (200) Opmal Moneary Polcy n a Currency Area. Mmeo. Deparmen of Economc. New York Unvery. Berger A.N. R. DeYoung and G.F. Udell (2000) Effcency Barrer o he Conoldaon of he European Fnancal Servce Indury. European Fnancal Managemen (forhcomng). Calvo G Saggered prce n a uly-maxmzng framework Journal of Moneary Economc Ceneno M. and A.S. Mello (999) How Inegraed are he Money Marke and he Bank Loan Marke Whn he European Unon? Journal of Inernaonal Money and Fnance (8): Danhne J.-P. F. Gavazz and E.-L. von Thadden (2000) European fnancal marke afer EMU: a fr aemen. Cenre for Economc Polcy Reearch (CEPR). Dcuon paper 243. London. Lemmen J. (998) Inegrang Fnancal Marke n he European Unon. Chelenham and Norhampon: Edward Elgar. Lombardo G. (2002) Imperfec Compeon Moneary Polcy and Welfare n a Currency Area. Mmeo. Deuche Bundebank Frankfur a.m. Germany.

21 9 Maron R.C. (985) Fnancal Durbance and he Effec of an Exchagne Rae Unon. In J. Bhandar (ed.): Exchange Rae Managemen Under Uncerany. Cambrdge Ma.: MIT Pre: Obfeld M. and K. Rogoff (995) Exchange rae dynamc redux Journal of Polcal Economy Obfeld M. and K. Rogoff (996) Foundaon of Inernaonal Macroeconomc. Cambrdge Ma.: MIT Pre. Schm-Grohe S. and M. Urbe (200) Clong mall open economy model manucrp Unvery of Pennylvana November 200. Senay Ö. (998) The Effec of Good and Fnancal Marke Inegraon on Macroeconomc Volaly. The Mancheer School Supplemen: Suherland A. (996) Fnancal marke negraon and macroeconomc volaly Scandnavan Journal of Economc Tlle C. (200) The role of conumpon ubuably n he nernaonal ranmon of moneary hock Journal of Inernaonal Economc

22 20 Fgure and Table Fgure Fnancal marke negraon and he dynamc repone of Home varable o a permanen Home echnology hock Noe: Dahed lne oban when eng 05. and old lne oban when eng 5.0. Conumpon oupu and he real exchange rae are meaured a percenage devaon from he eady ae. Bond holdng are meaured a percenage devaon from he eady ae conumpon level. The nere rae meaured n erm of percenage pon devaon from he eady ae. The producvy hock are aumed o evolve accordng o he fr-order auoregreve proce gven n Eq. (24) wh 0.. The Home and Foregn producvy hock are perfecly negavely correlaed.

23 2 Fgure 2 Fnancal marke negraon and he dynamc repone of Home varable o a ranory Home echnology hock Noe: Dahed lne oban when eng 05. and old lne oban when eng 5.0. Conumpon oupu and he real exchange rae are meaured a percenage devaon from he eady ae. Bond holdng are meaured a percenage devaon from he eady ae conumpon level. The nere rae meaured n erm of percenage pon devaon from he eady ae. The producvy hock are aumed o evolve accordng o he fr-order auoregreve proce gven n Eq. (24) wh 07.. The Home and Foregn producvy hock are perfecly negavely correlaed.

24 22 Fgure 3 Fnancal marke negraon and he dynamc repone of eleced unon-wde varable o a ranory aymmerc producvy hock Noe: The parameer decrbng he fr componen of he ranacon co for underakng cro-border fnancal ranacon e equal o The Unon-wde oupu compued a he populaon weghed um of he repecve naonal oupu level. Oupu he aggregae prce level and money demand are meaured a percenage devaon from he eady ae. The nere rae dfferenal meaured n erm of percenage pon devaon from he eady ae. The producvy hock are aumed o evolve accordng o he fr-order auoregreve proce gven n Eq. (24) wh 07.. The Home and Foregn producvy hock are perfecly negavely correlaed.

25 23 Table The calbraed parameer Parameer Value Decrpon /.05 Subjecve dcoun facor 6.0 Elacy of ubuon beween good produced n he ame counry 4.0 Elacy of ubuon beween Home and Foregn good 5.0 (0.5) Fr componen of co for underakng poon n nernaonal fnancal marke n he cae of low (hgh) capal mobly 0.05 Second componen of co for underakng poon n 2 nernaonal fnancal marke n 0.5 Counry ze.0 (0.7) Perence of a permanen (emporary) producvy hock 0.0 Sandard devaon of producvy hock

26 24 Table 2 Fnancal marke negraon and bune cycle volaly Parameer Value ŷ Panel A: 5. 0 ~ Panel A: 0. 5 ~ Ĉ Noe: The able repor andard devaon for Home oupu and conumpon ŷ for alernave value of he cro-counry elacy of good ~ and he parameer capurng he degree of prce ckyne. To compue he andard devaon 00 me ere of he endogenou varable of he model were generaed each me ere conng of 500 obervaon. In he mulaon wa aumed ha Home and Foregn producvy hock are perfecly negavely correlaed. The producvy hock are aumed o evolve accordng o he fr-order auoregreve proce gven n Eq. (24) wh 07.. Ĉ