A Small Open Economy with Staggered Wage Setting and Intertemporal Optimization: The Basic Analytics

21 Pages Posted: 3 Jul 2003

See all articles by John Fender

John Fender

University of Birmingham - Department of Economics

Neil Rankin

University of Warwick - Department of Economics; Centre for Economic Policy Research (CEPR)

Abstract

We develop a model of a small open economy with optimizing, infinitely lived agents. They have monopoly power over the price of their labour, and wage setting is staggered. We consider the effects of an unanticipated increase in the money supply. In all cases, the exchange rate depreciates immediately to its long-run value with no overshooting. With unitary elasticity of substitution in preferences between home and foreign goods, output rises instantaneously but gradually returns to its initial value in the long run. Trade remains balanced at all times. With an elasticity of substitution above unity, there is a trade surplus in the short run and a deficit in the long run, as permanently higher net foreign assets are accumulated. Convergence to the steady state is faster, and thus output persistence is smaller. With unitary elasticity the dynamics are the same as in an equivalent closed economy, so, to the extent that an elasticity greater than one is plausible for an open economy, we conclude that openness reduces output persistence.

Suggested Citation

Fender, John and Rankin, Neil, A Small Open Economy with Staggered Wage Setting and Intertemporal Optimization: The Basic Analytics. Available at SSRN: https://ssrn.com/abstract=420357

John Fender (Contact Author)

University of Birmingham - Department of Economics ( email )

Economics Department
Birmingham, B15 2TT
United Kingdom

Neil Rankin

University of Warwick - Department of Economics ( email )

Coventry CV4 7AL
United Kingdom
(44 1203) 523 470 (Phone)
(44 1203) 523 032 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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