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Monetary Policy and Sunspot Fluctuation in the U.S. and the Euro Area

August 2008
Yasuo Hirose*1

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Abstract

We estimate a two-country open economy version of the New Keynesian DSGE model for the U.S. and the Euro area, using Bayesian techniques that allow for both determinacy and indeterminacy of the equilibrium. Our empirical analysis shows that the worldwide equilibrium is indeterminate due to a passive monetary policy in the Euro area, even if U.S. policy is aggressive enough. We demonstrate that the impulse responses under indeterminacy exhibit different dynamics than those under determinacy and that sunspot shocks affect the Euro economy to a substantial degree, while the propagation of sunspots to the U.S. is limited.

Keywords:
Monetary Policy, Indeterminacy, Sunspot Shock, Open Economy Model, Bayesian Analysis

JEL Classification:
C11, C62, E52, F41

I would like to thank Giuseppe Ferrero, Ippei Fujiwara, Hibiki Ichiue, Masakazu Inada, Thomas Lubik, and Aarti Singh for insightful comments and discussions. The views in this paper are solely the responsibility of the author and should not be interpreted as reflecting the views of the Bank of Japan.

  • *1 International Department, Bank of Japan
    E-mail: yasuo.hirose@boj.or.jp

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