Working Paper: NBER ID: w1242
Authors: Nicholas Carlozzi; John B. Taylor
Abstract: The paper develops a two-country model with flexible exchange rates and perfect capital mobility, for evaluating the alternative macroeconomic policy rules. Macroeconomic performance is measured in terms of fluctuations in inflation and output. Expectations are rational, and prices are sticky; wagesetting is staggered over time. The countries are linked by aggregate spending effects, relative price effects, and mark-up pricing arrangements. The modelis solved and analyzed through deterministic and stochastic simulation techniques. The results suggest that international capital mobility is not necessarily an impediment to efficient domestic macroeconomic performance. Changes in the expected appreciation or a depreciation of the exchange rate along with differentials between real interest rates in the two countries can permit macroeconomic performance in one country to be relatively independent of the policy rule chosen by the other country. The results depend on the particular parameter values used in the model and suggest the need for further econometric work to determine the size of these parameters.
Keywords: international capital mobility; monetary policy; flexible exchange rates
JEL Codes: E52; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| exchange rate expectations (F31) | macroeconomic performance (E66) |
| interest rate differentials (E43) | macroeconomic performance (E66) |
| exchange rate expectations and interest rate differentials (F31) | aggregate spending and price mechanisms (E30) |
| international capital mobility (F21) | macroeconomic performance (E66) |