Putting Up a Good Fight:The Galí-Monacelli Modelversus “The Six MajorPuzzles in InternationalMacroeconomics”

In this paper, the following question is posed: Can the New KeynesianOpen Economy Model by Galí and Monacelli (2005b) explain “Six MajorPuzzles in International Macroeconomics”, as documented in Obstfeldand Rogoff (2000b)?The model features a small open economy with complete markets, Calvosticky prices and monopolistic competition. As extensions, I explore theeffects of an estimated Taylor rule and additional trade costs. After translatingthe six puzzles into moment conditions for the model, I estimatethe five most effective parameters using simulated method of moments(SMM) to fit the moment conditions implied by the data. Given the simplicityof the model, its fit is surprisingly good: among other things, thehome bias puzzles can easily be replicated, the exchange rate volatilityis formidably increased and the exchange rate correlation pattern is relativelyclose to realistic values. Trade costs are one important ingredientfor this finding.