New Directions for Stochastic Open Economy Models

48 Pages Posted: 24 Feb 2000 Last revised: 13 Oct 2010

See all articles by Maurice Obstfeld

Maurice Obstfeld

University of California, Berkeley; Peterson Institute for International Economics; National Bureau of Economic Research; Centre for Economic Policy Research

Kenneth Rogoff

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: August 1999

Abstract

The paper develops a simple stochastic new open economy macroeconomic model based on sticky nominal wages. Explicit solution of the wage-setting problem under uncertainty allows one to analyze the effects of the monetary regime on welfare, expected output, and the expected terms of trade. Despite the potential interplay between imperfections due to sticky wages and monopoly, the optimal monetary policy rule has a closed-form solution. To motivate our model, we show that observed correlations between terms of trade and exchange rates are more consistent with our traditional assumptions about nominal rigidities than with a popular alternative based on local-currency pricing.

Suggested Citation

Obstfeld, Maurice and Rogoff, Kenneth S., New Directions for Stochastic Open Economy Models (August 1999). NBER Working Paper No. w7313. Available at SSRN: https://ssrn.com/abstract=197728

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