EXCHANGE RATES, TERMS OF TRADE AND EMPLOYMENT: PITFALLS IN MACROECONOMIC MODELS OF OPEN ECONOMIES

Egon Sohmen

Kyklos, 1974, vol. 27, issue 3, 521-536

Abstract: Most macroeconomic models of open economies incorporate an algebraic misspecification when they introduce the possibility of exchange‐rate adjustments. The traditional treatment of this issue along the lines inaugurated by Laursen and Metzler in 1950 is shown to be misleading in some important respects. In order to diagnose the nature of the international transmission of business cycles correctly, it is necessary to differentiate clearly between changes in the nominal values of the trade balance in domestic and in foreign currency and changes in physical units of exports and imports. A correct treatment is shown to reverse even the sign of the employment effects of certain types of trade adjustments which some authors have deduced from incorrectly specified models.

Date: 1974
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