Money and the Open Economy Business Cycle: a Flexible Price Model
49 Pages Posted: 19 Jun 2004
Date Written: June 1986
This paper develops an open-economy model of the business cycle. Thenominal prices in the model are flexible and monetary nonneutrality isdeveloped using information confusion about the sources of disturbances todemand coupled with differential persistence of demand shocks. Firms useinventories to smooth their production, and consumers follow a stochasticpermanent income expenditure function. The major implication of the modelis that unperceived monetary disturbances improve the terms of trade andincrease real output in contrast to sticky price models in which the termsof trade deteriorates. This implication of the model is examinedempirically.
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