Working Paper: CEPR ID: DP168
Authors: Th van de Klundert; Frederick van der Ploeg
Abstract: This paper formulates an optimizing model of a small open economywith a representative (immortal) household, a firm and agovernment. The asset menu consists of domestic currency,non-traded bonds and traded bonds. There is a risk-premium ontraded bonds, which leads to deviations from perfect capitalmobility and UIP. Taxes are lump-sum, so that finance by bonds andby taxation are equivalent. The model allows for current-accountand wealth dynamics. There are six versions of the model dependingon whether one assumes purchasing power parity or imperfectsubstitution between home and foreign goods and on whether there islabour market equilibrium, nominal wage rigidity or real wagerigidity. For each of these variants, the steady-state effects of afiscal contraction, monetary disinflation, a worsening of thesupply side, an increase in the world interest rate, and a resourcediscovery are discussed. The transient effects of these policiesfor some of these versions are analysed with the aid of a "multipleshooting" algorithm.
Keywords: small open economy; capital mobility; purchasing power parity; wage rigidity; fiscal policy; monetary policy
JEL Codes: 430
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| monetary disinflation (E31) | appreciation of the real exchange rate (F31) |
| appreciation of the real exchange rate (F31) | short-term job losses (J63) |
| monetary disinflation (E31) | short-term job losses (J63) |
| fiscal expansion (E62) | increase in output (E23) |
| fiscal expansion (E62) | increase in employment (J68) |
| fiscal expansion (E62) | reduce the wedge between producers' and consumers' wages (F16) |
| resource discoveries (L72) | increase in real wealth (E21) |
| increase in real wealth (E21) | deterioration of the current account (F32) |
| resource discoveries (L72) | deterioration of the current account (F32) |