New Directions for Stochastic Open Economy Models

Maurice Obstfeld and Kenneth Rogoff

Department of Economics, Working Paper Series from Department of Economics, Institute for Business and Economic Research, UC Berkeley

Abstract: The paper develops a simple stochastic new open economy macroeconomic model based on sticky nominal wages. Explicit solution of the wage-setting problem under uncertainty allows one to analyze the effects of the monetary regime on welfare, expected output, and the expected terms of trade. Despite the potential interplay between imperfections due to sticky wages and monopoly, the optimal monetary policy rule has a closed-form solution. To motivate our model, we show that observed correlations between terms of trade and exchange rates are more consistent with our traditional assumptions about nominal rigidities than with a popular alternative based on local-currency pricing.

Keywords: new open-economy macroeconomics; currency risk; pricing to market; international policy transmission; optimal monetary policy (search for similar items in EconPapers)
Date: 1999-09-01
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Citations: View citations in EconPapers (48)

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