Working Paper: NBER ID: w2372
Authors: Rudiger Dornbusch
Abstract: The paper reviews the directions of research that offer important insights into open economy macroeconomic policy: pricing, waiting and expectations. The pricing discussion centers on the recognition that firms are price setters. This implies that industry shocks such as exchange rate movements or changes in commercial policy have effects on output and prices different from the standard model of a small country under perfect competition. Industrial organization considerations including market structure and product differentiation determine the impact of shocks on output and prices. Extensions of work on irreversible investment, drawing on the option literature, shows the value of waiting. In open economy macroeconomics this theory can be applied not only to questions of employment but also to such topics as the return of capital flight. The expectations literature is being extended to more ambitious stochastic models of policy. If agents extrapolate current disturbances, say in money, and expect a cumulative deviation of money from and initial path there will be large immediate effects of money innovations on exchange rates. These new models extend the Mundell- Fleming models by showing that even small changes in the growth rate of money can bring about large changes, and volatility, in exchange rates.
Keywords: Open Economy Macroeconomics; Exchange Rates; Monetary Policy; Industrial Organization; Investment; Expectations
JEL Codes: F41; E52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increase in the money supply (E51) | Real depreciation of the currency (F31) |
| Real depreciation of the currency (F31) | Improvement in the external balance (F32) |
| Increase in the money supply (E51) | Improvement in the external balance (F32) |
| Exchange rate movements (F31) | Differentiated impacts on output and prices (F61) |
| Exchange rate movements (F31) | Output (Y10) |
| Exchange rate movements (F31) | Prices (D49) |
| Money supply innovations (E51) | Changes in exchange rates (F31) |
| Public expectations (D84) | Changes in exchange rates (F31) |
| Decision to invest (G11) | State of demand (R22) |
| Adverse conditions (Q54) | Decision to invest (G11) |