decrease. There is also unemployment in Foreign country. Therefore, Home default shock drives an international crisis in our model.
5.3 Monetary Policy Shock
Figures 9 to 12 plot the impulse responses to a negative 1% Home monetary policy (see page 39 to page 42 respectively). The contraction monetary policy also triggers a recession across countries. Output, investment, loans, and employment fall in both countries. Note that the negative monetary policy shock causes a sizeable decay in Home investment. Home real wage behaves persistently decreases. For Foreign country, the dynamic paths and international transmission mechanism are equivalent the same as the default shock experiment.
6 Concluding Remarks
The global financial crisis has highlighted the financial factor and the role of financial intermediation in the propagation of international business cycles. The importance of embedding banking sector with DSGE model has been growing in literatures. To investigate the international transmission mechanism of financial shock, this paper proposes a two-country two-bank New Keynesian model. The crisis is triggered by entrepreneur defaulting on their borrowings.
The calibration results suggest that the model predicts an international crisis with a Home default shock as well as a negative Home monetary policy shock. The country-specific default shock to Home intermediate goods firm not only causes a
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recession in Home country but transmits the financial shock to Foreign country. As the repayments is less than contractual agreed to financial intermediation, the liquidity in the economy is becoming more inadequate. Intermediate goods firm finances funds from banking sector for purchasing capital; therefore, with the shortage of liquidity, the financial mechanism magnifies the fluctuations. The Home country-specific shocks transmit to Foreign country through bank deposits and the international trade channel.
With Home household saves less in Foreign bank and the fall of Home intermediate goods export, Foreign loanable funds decreases as well as Foreign final goods output.
To concentrate on formulating a two-country two-bank New Keynesian model, we leave a number of issues for further works. Sensitivity analysis is absent from our study as well as the optimal monetary policy. The international loan channel is also be simplified in our model. It would be interesting to investigate these issues to understand more details of international business cycles with financial intermediation.
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Parameter Description Value
Calibrated parameters
Capital ratio 0.36
Discount factor 0.9938
Depreciation rate 0.025
Deposit preference 0.014
Labor supply aversion 1v Elasticity of substitution between
Home and Foreign intermediate goods 5
Imported goods share 0.2
Price elasticity of demand 6
Nominal rigidity 0.75
Required banking capital ratio 0.07 Autocorrelation of shocksStandard deviation of shocks
A Productivity 0.0053
Default 0.000282
R Policy rate 0.0016‧ 國
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Table 2: Steady-state
Variable Description Value
CH Household consumption 2.1664
CB Bank consumption 0.0116
C Aggregate consumption 2.1779
I Investment 0.6407
Y Output 2.8796
K Capital input 25.6286
w Real wage 1.8240
N employment 0.8420
L Loan 25.6286
DW Aggregate deposit in bank 23.8346 RD Deposit rate (p.a.) 1.47%
RL Contractual loan rate (p.a.) 3.48%
e
RL Effective loan rate (p.a.) 2.5%
R Policy rate (p.a.) 2.5%
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Figure 1: Productivity shock
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Figure 2: Productivity shock (cont.)
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Figure 3: Productivity shock (cont.)
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Figure 4: Productivity shock (cont.)
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Figure 5: Default shockh engchi U ni ve rs it y
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Figure 6: Default shock (cont.)
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Figure 7: Default shock (cont.)
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Figure 8: Default shock (cont.)
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Figure 9: Monetary policy shock
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Figure 10: Monetary policy shock (cont.)
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Figure 11: Monetary policy shock (cont.)
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Figure 12: Monetary policy shock (cont.)
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Appendix A: Foreign country equations A.1 Household
The First-order conditions of the Foreign worker’s optimization are,
A.2 Final goods producer
The production function is,
1
1
, 1 1
, 1 1.The First-order conditions of the Foreign retailer are,
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The aggregate price index yields,
A.3 Intermediate goods producer
The technology is,
1, .
E t t t t
Y A K N
The finance of capital acquisition,
1.
t t t
L Q K
The evolution of capital accumulation equation is according to,
1 1 .
t t t
K
K
IThe optimal labor and capital demand decisions,
1
E t, ,‧
Therefore, the (nominal) marginal cost,
1 ,
1
1 The optimal pricing strategy,
The evolution of intermediate goods price,
1
1 11, , 1 1 opt, .
E t E t E t
P
P
P
A.4 Banker
The definition of excess banking capital,
1
1 W1.The dynamic of loan rate spreads,
, 1 , 1 (0) (0) .
e
L t D t D L t
R
R
x The banker’s optimal (real) consumption,‧
Therefore, the relationship between bank wealth and banking capital,
1
1
1
1
1 1‧
Appendix B: Endogenous deposit rate
As the steady-state assumption that we describe in section 4, from equation (3) and (4), we can obtain dH dF. The steady-state deposit holding is,
The steady-state of equation (5) is,
H . c w
N
Hence, equation (A.1) can be written as,