FraNK: Fragmentation in the NK Model

Abstract

We set up a multi-country New Keynesian model to study the effects of a geoeconomic fragmentation shock, modelled as an increase in the tax rates on goods, commodities, and bonds purchased from rival countries. First, we derive a closed-form solution of the model by using a symmetric calibration on two blocks of countries and we show analytically that geoeconomic fragmentation reduces output. The effect on PPI inflation is ambiguous, depending positively on the importance of commodities in the production function. Then, we calibrate the model for four regions (the United States, their allies, a China-led block, and the neutral rest of the world) and find that fragmentation predominantly affects the China-aligned bloc and the US allies, with these countries experiencing larger declines in production and consumption. In contrast, the US are relatively shielded from the shock because of their limited exposure to the rival bloc. The spillovers to neutral countries are negligible.

Keywords: open economy macroeconomics, financial aspects of economic integration, economic impacts of globalization, capital flows

JEL Classification: F36, F41, F62, F65