Inflation Targeting in Canada: An Expected Loss Analysis by a DSGE Model with Trade Costs Graduate Student Working Paper Series, Vanderbilt University, May 2008.

This paper develops an open economy DSGE model with an emphasis on trade costs to evaluate the performance of the Bank of Canada in the Canadian inflation targeting experience. For model parametrization, the New-Keynesian Phillips curve for the Canadian economy, together with the monetary policy rule of the Bank of Canada, is estimated. When a utility-based expected loss function is considered, the Bank of Canada is found to be far from being optimal in its actions, independent of trade costs. When an ad hoc expected loss function considering the volatilities in inflation, output and interest rate is considered, it is found that the actions of the Bank of Canada are explained best when trade costs in fact exist but the Bank of Canada ignores them. In other words, the Bank of Canada can employ a better monetary policy by considering the existence of trade costs. Thus, trade costs play an important role in forming the monetary policy rules, which is ignored in the literature. Finally, given the ad hoc loss function, the actions of the Bank of Canada are best explained when 70% of weight is assigned to inflation, 15% of weight to interest rate and 15% of weight to output.

Understanding Interstate Trade Patterns

This paper attempts to find the motivation behind interstate trade patterns within the U.S. by using a partial equilibrium trade model. In particular, why does a region import more goods from a particular region while importing fewer from others? Why does a region import more of a particular good, while importing less of another one? The answers emerge from the simple model set forth by this paper that considers the geographical and technological differences across regions and goods. By construction, the model, together with the estimation methodology, controls for possible local (i.e., wholesale and retail) distribution costs, insurance costs, local taxes, markup differences in production, and intermediate input trade as well as zero trade observations, which are ignored in most gravity type studies. Moreover, the elasticity of substitution across goods, the elasticity of substitution across varieties of each good, and the good specific elasticity of distance measures are all identified in the empirical analysis, which is also not the case in most gravity type studies. Compared to empirical international trade literature, the elasticity of substitution is estimated to be lower, while the elasticity of distance is estimated to be higher intranationally.

 

A Model of International Cities: Implications for Real Exchange Rates (with Mario Crucini)

This paper develops a model of international cities where two representative residents in each city specialize in manufacturing and services. The manufactured good is exported from the city of production to all destination cities. The services represent the physical transformation of these traded goods from the factory gate to the final consumer. Both activities use only local labor available in the city production takes place. Implications of the model for price dispersion and trade patterns are derived. Using a panel of micro-prices at the city level, the model's implications for price dispersion is evaluated. This is an ongoing project. More details are on the way...