Relative Prices, Employment, and the Exchange Rate in an Economy with Foresight

48 Pages Posted: 18 Aug 2004

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

Date Written: June 1981

Abstract

This paper studies the effects of monetary policy in a small, open economy with a floating exchange rate, sticky wages, and rational expectations in both the asset and labor markets. The model developed emphasizes the link between exchange-rate depreciation and nominal wage inflation, embodying it in an expectations-augmented Phillips curve. The economy studied produces both traded and non-traded goods, and thus provides a framework in which to explore the connection between the dynamic behavior of the exchange rate and the supply structure and degree of openness of the economy. In addition, the paper examines the "vicious circle" hypothesis, showing how an explosive cycle of exchange-rate depreciation and wage-price inflation may arise in response to an expected monetary expansion.

Suggested Citation

Obstfeld, Maurice, Relative Prices, Employment, and the Exchange Rate in an Economy with Foresight (June 1981). NBER Working Paper No. w0685. Available at SSRN: https://ssrn.com/abstract=349085

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Centre for Economic Policy Research ( email )

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