The new open economy macroeconomics.docx

The new open economy macroeconomics.docx

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Thenewopeneconomymacroeconomics

Thenewopeneconomymacroeconomics:

asurvey

PhilipR.Lane

EconomicsDepartment,TrinityCollegeDublinandCEPR,Dublin2,Ireland

Received28July1999;

accepted20December1999

Availableonline19April2001.

Abstract

Sincethe1995publicationofObsteldandRogoff’sReduxmodel,therehasbeenanoutpouringofresearchonopen-economydynamicgeneralequilibriummodelsthatincorporateimperfectcompetitionandnominalrigidities.Thispaperoffersaninterimsurveyofthisrecentliterature.

AuthorKeywords:

Newopeneconomymacroeconomics;Nominalrigidities;Imperfectcompetition

JELclassificationcodes:

F3;F4

ArticleOutline

1.Introduction

2.Exchangeratedynamicsredux

3.Nominalrigidities

3.1.Stickywages

3.2.Staggering

4.Marketsegmentationandpricingtomarket

4.1.Pricingtomarket

4.2.Translogpreferences

5.Preferencesandtechnology

5.1.Consumptionpreferences

5.2.Consumptionelasticityofmoneydemand

5.3.Consumption-leisurenon-separability

5.4.Addingcapital

5.5.Non-tradedgoodsandhomebias

6.Financialstructure

6.1.Financialmarketcompleteness

6.2.Tradingfrictions

7.Internationalpolicyinterdependence

8.Introducinguncertainty

9.Marketstructure

10.Thesmallopeneconomymodel

11.Empirics

11.1.Matchingunconditionalmoments

11.2.VARevidence

11.3.Otherevidence

11.4.Parameterestimation

12.Conclusions

Acknowledgements

References

1.Introduction

Thisarticlesurveyssomerecenteffortstodevelopanewworkhorsemodelforopen-economymacroeconomicanalysis.1Theunifyingfeatureofthisemergingliteratureistheintroductionofnominalrigiditiesandmarketimperfectionsintoadynamicgeneralequilibriummodelwithwell-specifiedmicrofoundations.

Imperfectcompetition–whetherinproductorfactormarkets–isakeyingredientinthenewmodels.Onereasonisthat,incontrasttoperfectcompetition（underwhichagentsareprice-takers）,monopolypowerpermitstheexplicitanalysisofpricingdecisions.Second,equilibriumpricessetabovemarginalcostrationalizedemand-determinedoutputintheshortrun,sincefirmsarenotlosingmoneyontheadditionalproduction.2Third,monopolypowermeansthatequilibriumproductionfallsbelowthesocialoptimum,whichisadistortionthatcanpotentiallybecorrectedbyactivistmonetarypolicyintervention.

Thisapproachoffersseveralattractions.Thepresentationofexplicitutilityandprofitmaximizationproblemsprovideswelcomeclarityandanalyticalrigor.Moreover,itallowstheresearchertoconductwelfareanalysis,therebylayingthegroundworkforcrediblepolicyevaluation.Allowingfornominalrigiditiesandmarketimperfectionsaltersthetransmissionmechanismforshocksandalsoprovidesamorepotentroleformonetarypolicy.Inthisway,byaddressingissuesofconcerntopolicymakers,onegoalofthisnewstrandofresearchistoprovideananalyticalframeworkthatisrelevantforpolicyanalysisandoffersasuperioralternativetotheMundell–Flemingmodelthatisstillwidelyemployedinpolicycirclesasatheoreticalreferencepoint.

Indescribingthefindingsofthisresearchprogram,Ifocusalmostexclusivelyontheanalysisofmonetaryshocks.Thisreflectstheemphasisintheliterature,fortheroleofnominalrigiditiesismoststarklyillustratedinthecaseofmonetaryshocksanditisthiskindofdisturbancethatflexible-pricemodelsareleastwell-equippedtohandle.

ObstfeldandRogoff（1995a）iscommonlyrecognizedasthecontributionthatlaunchedthisnewwaveofresearchandthispaperisreviewedinSection2below.AnimportantprecursorwasthepaperbySvenssonandvanWijnbergen（1989）.Thispaperisamanifestoforsticky-pricemodelsthathavesolidmicrofoundationsandarefirmlyembeddedinanintertemporalsettingandmuchoftheanalyticstructureofthatpaperhasbeenadoptedinthemorerecentliterature.However,theseauthorsmodelledhomeandforeignoutputsasstochasticendowmentsandthesubsequentliteraturehasdevotedmuchmoreattentiontoendogenizingtheproductionsideoftheeconomy.Krugman（1995）alsosignalledmanyoftheresearchissueswhichhavereceivedattentioninthisnewliterature.

Finally,itshouldbenotedthattheresearchprogramdescribedhereisverymuchlinkedtodevelopmentsinclosed-economymacroeconomics.Thereisasensethatmacroeconomistsareconvergingonacommonmodellingframeworkthatintegratesimperfectcompetitionandnominalrigiditiesintodynamicgeneralequilibriummodels.Thisrecentdevelopmenthasbeenlabelled‘neomonetarism’byKimball（1995）andthe‘newneoclassicalsynthesis’byGoodfriendandKing（1997）.

Therestofthepaperisorganizedasfollows.TheObstfeld–RogoffReduxmodelisbrieflyoutlinedinSection2.Section3reviewsalternativeapproachestomodellingnominalrigidity.TheimpactofmarketsegmentationandpricingtomarketbehaviorisdiscussedinSection4.WeturntothespecificationofpreferencesandtechnologyinSection5.Section6introducesvariationinfinancialstructure.TheanalysisofinternationalpolicyinterdependenceisreviewedinSection7.Section8discussestheoreticalframeworksthatexplicitlyallowforuncertaintyandSection9alternativeapproachestomodellingmarketstructure.SmallopeneconomymodelsarethesubjectofSection10.Section11reviewsthebodyofempiricalworkassociatedwiththisnewresearchprogram.Section12concludes.

2.Exchangeratedynamicsredux

AswasnotedintheIntroduction,ObstfeldandRogoff（1995a）effectivelyinitiatedthisnewresearchprogram.3Inthissection,webrieflyoutlinethemainfeaturesoftheirReduxmodel.Theysetupatwo-countrymodel.Eachcountryispopulatedbyacontinuumofyeoman-farmers（consumer-producers）thatproducedifferentiatedgoods（[0,n]liveinthehomecountry;（n,1]intheforeigncountry）.Preferencesforindividualjinthehomecountryaregivenby4

（1）

whereσ,

>0,μ>1,0<β<1andCisaCESindexaggregatingacrossthedifferentiatedvarietiesoftheconsumptiongood

（2）

whereθistheelasticityofsubstitutionbetweenvarieties.Goods[0,n]areproduceddomesticallyand（n,1]overseas:

homeandforeigngoodsentersymmetricallyintopreferences.Thecorrespondingpriceindexis

（3）

Mt/Ptaretherealbalancesheldinperiodtandthelasttermin

（1）capturesthedisutilityofworkeffort.Thereisnocapitalinthemodel.Itfollowsfrom

（2）thateachconsumer-producerfacestheconstant-elasticitydemandcurveforhisoutput

（4）

whereCtwisaggregateglobalconsumption.Moneyisintroducedintotheeconomybythegovernment.Assumingzerogovernmentconsumption,therevenueearnedfrommoneycreationisreturnedintheformoftransfers（Tt<0）

（5）

Agentshaveaccesstoaninternationalrisklessrealbondmarketattheconstantinterestrater.Thedynamicbudgetconstraintisgivenby

（6）PtBtj+Mtj=Pt（1+r）Bt−1j+Mt−1j+pt（z）yt（z）−PtCt−PtTtwhereBtjisagentj’sbondholdingenteringperiodt+1.

Homeandforeignindividualsareassumedtohaveidenticalpreferencesandtherearenobarrierstotradesuchthatthelawofonepriceholdsforeachgood.Theseassumptionsmeanthatpurchasingpowerparityholdsandtheconsumption-basedrealexchangerateisconstant.

Eachagentmustdecideheroptimalchoicesofconsumption,moneyholding,laborsupplyandsetheroptimaloutputprice.Pricesareassumedtobesetoneperiodinadvance,introducinganominalrigidityintothemodel.Thesolutiontechniqueistofirstsolveforasteadystateofthemodel.Tostudythedynamiceffectsofamonetaryshock,alog-linearapproximationistakenaroundthissteadystate.Sincepricesarestickyforoneperiod,thesolutiondistinguishesbetweentheimpact（first-period）effectofashockanditslong-runsteady-stateeffect.Accordingly,thewelfareeffectofashockiscalculatedasthesumoftheshort-runchangeinutilityandthediscountedpresentvalueofthechangeinsteady-stateutility.

TheauthorsconsidertheDornbuschexperimentofaunanticipatedpermanentincreaseinthedomesticmoneysupply.Theimpacteffectofthemonetaryshockisanincreaseinthelevelofdomesticoutputandconsumption.Theworldrealinterestratefallsandnominaldepreciationtranslatesintoadeclineinthedomestictermsoftrade:

bothfactorsgenerateanincreaseinforeignconsumption.Theimpactonforeignoutputisambiguous,sincetheincreaseinaggregateconsumptionandtherelativepriceshiftworkinoppositedirections.Thedomesticcurrentaccountmovesintosurplus.

Inthiscase,moneyisnotneutralinthelongrun.Theshort-rundomesticcurrentaccountsurplusimpliesapermanentimprovementindomesticnetforeignassets.Inthesteadystate,thisimpliesapermanentdomestictradedeficitsinceapositivenetinvestmentincomeinflowallowsconsumptiontoremainpermanentlyabovedomesticoutput.Thewealtheffectofthepositivenetforeignassetpositionreducesdomesticlaborsupply（leisureisanormalgood）anddomesticoutput,therebygeneratingapermanentimprovementinthehomecountry’stermsoftrade.

Aninterestingresultisthatexchangerateovershootingisnotpossibleinthismodel.Toseethis,itisusefultopresenttheequationsforPPP,consumptiongrowthandshort-runandlong-runmonetaryequilibrium

（7）

（8）

（9）

（10）

where‘

’denotesshort-runvaluesand‘−’denoteslong-runvalues,respectively.InEq.（7）,PPPimpliesthatchangesinthenominalexchangeratejustmatchinflationdifferentials.Eq.（8）combinesthehomeandforeignconsumptionEulerequations:

sincePPPholds,domesticandforeignagentsfacethesamerealinterestrateanddomesticandforeignconsumptiongrow