Demand Shocks and Intertemporal Coordination: A Two Country Model

The effect of demand shocks is studied within an economy characterized by a temporally articulated production structure, and populated by boundedly rational agents. Hicks’ (1973) model is extended in order to include trade between two economies with demand links. This allows to tackle issues as the transmission of shocks and the coordination of monetary policies between countries. By means of numerical simulations, I show that temporary demand shocks trigger disequilibrium dynamics that have permanent effects on the economy. The reason has to be found in the irreversibility that characterizes the technological structure and the decision process. Furthermore, market imperfections, namely a certain degree of wage and price stickiness, prove necessary to avoid the implosion of the system. An accommodating monetary policy, by softening financial constraints, is effective in stabilizing the economy. Finally, when considering trading economies, a certain degree of openness has positive effects, and independent monetary policies may in some occasions be desirable. ∗[email protected]. I thank Mario Amendola and Jean-Luc Gaffard for introducing me to this stream of research, and for comments and suggestions since the early stages of the project. I also profited of discussions with Andrea Attar and Alessandra Casella. Duncan Foley and Alexei Onatski gave me sharp comments on previous drafts. Finally, I had feedback from participants to seminars at Columbia University and to the workshop ”Innovation and Growth: New Challenges for the Regions”, Sophia Antipolis, France, January 2002. Any error is of course mine. For the simulations I modified a code written by Elena Lega; I warmly thank her and Alessandra Iacobucci for their help. Financial support from Idefi-CNRS is gratefully acknowledged.