Foreign Prices Shocks in a Small Open Economy

Maria Halldor Gestsson ()
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Maria Halldor Gestsson: School of Economics and Management, University of Aarhus, Denmark, Postal: 8000 Aarhus C, Denmark

Economics Working Papers from Department of Economics and Business Economics, Aarhus University

Abstract: Countries specialize in producing goods that they have comparative advantages in producing. This results in a country exporting some goods while it imports other. Hence, there is a reason to expect that changes in the prices of these goods have consid- erable economic e¤ect and that demand management can be used to improve welfare following such changes. This paper analyses this using a New Open Economy Macro (NOEM) model of a small open economy. Among others, the results indicate that, in a small open economy, a terms of trade appreciation results in increased consumption, labor use and output on impact while consumption increases but labor use and output decrease in future time periods. The results also indicate that the vulnerability of an economy towards such shocks is negatively related to its size. Finally, the results indicate that there exists a welfare improving demand management policy following a terms of trade shock.

Keywords: Open Economy Macroeconomics; New Open Economy Macro Models; small open economy; tradeables; exportables; importables; terms of trade; demand management; stabilization (search for similar items in EconPapers)
JEL-codes: E63 F41 (search for similar items in EconPapers)
Pages: 34
Date: 2007-06-01
New Economics Papers: this item is included in nep-mac and nep-opm
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