A Two-Country Model with Asymmetric Phillips Curves and Intervention in the Foreign Exchange Market

In this paper simulation methods are employed on a two-country, rational expectations continuous-time model to explore the consequences of asymmetrical wage-price processes. As an additional feature the effects are explored of reductions in the degree of financial integration between the two countries. The set up is designed to mimic the asymmetry within the European Monetary System between the wage-price process in Germany and that in the other member countries. The results demonstrate that country differentiation in respect of the wage-price process has important leverage on the response to a variety of shocks and that reduced financial integration (mimicking foreign exchange controls) is an uncertain offset.