Asymmetries in an open economy model

This paper revisits interdependence in a NOEM framework introducing two asymmetries in a two-country general equilibrium model of the world economy with imperfect competition and nominal rigidities: a world with asymmetric nominal rigidities, where one country has flexible prices and the other sticky prices, and a world with asymmetric behavior from monetary policymakers, where one country non-optimally sets a constant nominal exchange rate. We show that the welfare loss is not dependent on the variance of the productivity shock in the first asymmetric world. As regards the second asymmetry we show that welfare gains arise under discretionary policy if the shock is higher than expected by agents at the cost of a welfare loss to the other country, whereas under monetary policy with rules a welfare loss happens in both countries. We also call into question the zero lower bound constraint in an open economy, endorsing expectations of price increases as an escape from a liquidity trap.