Working Paper: NBER ID: w1967
Authors: Robert P. Flood; Robert J. Hodrick
Abstract: This paper develops an open-economy model of the business cycle. The \nnominal prices in the model are flexible and monetary nonneutrality is \ndeveloped using information confusion about the sources of disturbances to \ndemand coupled with differential persistence of demand shocks. Firms use \ninventories to smooth their production, and consumers follow a stochastic \npermanent income expenditure function. The major implication of the model \nis that unperceived monetary disturbances improve the terms of trade and \nincrease real output in contrast to sticky price models in which the terms \nof trade deteriorates. This implication of the model is examined \nempirically.
Keywords: business cycle; monetary policy; open economy
JEL Codes: E32; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| unperceived monetary disturbances (E39) | improvements in the terms of trade (F14) |
| improvements in the terms of trade (F14) | increased real output (E23) |
| unperceived monetary disturbances (E39) | increased real output (E23) |
| information confusion about demand shocks (E32) | unperceived monetary disturbances (E39) |
| misinterpretation of positive money supply shock (E51) | increase in output and relative prices (O49) |