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Imperfect international risk sharing and exchange rate volatility matter for how monetary policy should optimally be conducted in an open economy through affecting policymakers’ terms of trade considerations. I study these motives for a classical and long‐standing question in international monetary economics: the size of potential gains from international policy coordination. In a relatively standard model I allow for various degrees of risk sharing by considering different assumptions on international financial markets, and a large region for the crucial parameter of the trade elasticity. When incomplete markets give rise to high volatility of international prices and poor risk sharing—such as in Corsetti, Dedola, and Leduc (2008)—gains from policy coordination are an order of magnitude larger than previous studies, working under the assumptions of complete markets, suggest.

We compare the performance of the perturbation-based (local) portfolio solution method of Sutherland (2010a, 2011) with a global solution method. We find that the local method performs very well when the model is designed to capture stylized macroeconomic facts and countries/agents are symmetric, i.e. when the latter have similar size, face similar risks and trade assets with similar risk properties. It performs less satisfactory when the agents engaged in financial trade are asymmetric. The global solution method performs substantially better when the model is parameterized to match the observed equity premium, a key stylized finance fact.

& Monetary Union (EMU). The model includes both nominal and real frictions that have proven to be important in matching business cycle facts, and that allows for an investigation of the effects and cross-country transmission of a number of structural shocks: shocks to technologies, shocks to preferences, cost-push type shocks and policy shocks. The model is estimated using Bayesian methods on quarterly data covering the period of 1976:Q1-2005:Q1. In addition to the assessment of the relative importance of various shocks, the model also allows to investigate effects of the monetary regime switch with the final stage of the EMU and investigates in how far this has altered macroeconomic transmission. We find that Austria's economy appears to react stronger to demand shocks, while in the rest of the Euro Area supply shocks have a stronger impact. Comparing the estimations on pre-EMU and EMU subsamples we find that the contribution of (rest of the) Euro Area shocks to Austria's business cycle fluctuations has increased significantly.

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