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Relative Prices, Employment, and the Exchange Rate in an Economy with Foresight

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  • Obstfeld, Maurice

Abstract

This paper studies the effects of monetary policy in a small, open economy with a floating exchange rate, sticky wages, and rational expectations in both the asset and labor markets. The model developed emphasizes the link between exchange-rate depreciation and nominal wage inflation, embodying it in an expectations-augmented Phillips curve. The economy studied produces both traded and non-traded goods, and thus provides a framework in which to explore the connection between the dynamic behavior of the exchange rate and the supply structure and degree of openness of the economy. In addition, the paper examines the "vicious circle" hypothesis, showing how an explosive cycle of exchange-rate depreciation and wage-price inflation may arise in response to an expected monetary expansion.

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Bibliographic Info

Article provided by Econometric Society in its journal Econometrica.

Volume (Year): 50 (1982)
Issue (Month): 5 (September)
Pages: 1219-42

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Handle: RePEc:ecm:emetrp:v:50:y:1982:i:5:p:1219-42

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References

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  1. Bruno, Michael, 1980. "Import Prices and Stagflation in the Industrial Countries: A Cross-Section Analysis," Economic Journal, Royal Economic Society, vol. 90(359), pages 479-92, September.
  2. Robert E. Hall, 1980. "Employment Fluctuations and Wage Rigidity," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 11(1, Tenth ), pages 91-142.
  3. Wilson, Charles A, 1979. "Anticipated Shocks and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 87(3), pages 639-47, June.
  4. Calvo, Guillermo A, 1977. "The Stability of Models of Money and Perfect Foresight: A Comment," Econometrica, Econometric Society, vol. 45(7), pages 1737-39, October.
  5. Jeffrey D. Sachs, 1979. "Wages, Profits, and Macroeconomic Adjustment: A Comparative Study," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 10(2), pages 269-332.
  6. Burgstaller, Andre, 1980. "Flexible exchange rates, unemployment and stabilization policy effectiveness," Journal of International Economics, Elsevier, vol. 10(3), pages 341-355, August.
  7. Calvo, Guillermo A & Rodriguez, Carlos Alfredo, 1977. "A Model of Exchange Rate Determination under Currency Substitution and Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 617-25, June.
  8. Basevi, Giorgio & De Grauwe, Faul, 1977. "Vicious and virtuous circles: A theoretical analysis and a policy proposal for managing exchange rates," European Economic Review, Elsevier, vol. 10(3), pages 277-301.
  9. William H. Branson & Julio J. Rotemberg, 1991. "International Adjustment with Wage Rigidity," NBER Chapters, in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 13-44 National Bureau of Economic Research, Inc.
  10. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  11. Sargent, Thomas J & Wallace, Neil, 1973. "The Stability of Models of Money and Growth with Perfect Foresight," Econometrica, Econometric Society, vol. 41(6), pages 1043-48, November.
  12. Erich Spitäller, 1980. "Short-Run Effects of Exchange Rate Changes on Terms of Trade and Trade Balance (Incidence à court terme des variations du taux de change sur les termes de l'échange et la balance commerciale) (Efe," IMF Staff Papers, Palgrave Macmillan, vol. 27(2), pages 320-348, June.
  13. Sachs, Jeffrey, 1980. "Wages, Flexible Exchange Rates, and Macroeconomic Policy," The Quarterly Journal of Economics, MIT Press, vol. 94(4), pages 731-47, June.
  14. Phelps, Edmund S & Taylor, John B, 1977. "Stabilizing Powers of Monetary Policy under Rational Expectations," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 163-90, February.
  15. Gray, Malcolm R & Turnovsky, Stephen J, 1979. "The Stability of Exchange Rate Dynamics under Perfect Myopic Foresight," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 20(3), pages 643-60, October.
  16. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
  17. Bruno, Michael, 1978. "Exchange Rates, Import Costs, and Wage-Price Dynamics," Journal of Political Economy, University of Chicago Press, vol. 86(3), pages 379-403, June.
  18. Kravis, Irving B. & Lipsey, Robert E., 1978. "Price behavior in the light of balance of payments theories," Journal of International Economics, Elsevier, vol. 8(2), pages 193-246, May.
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Cited by:
  1. AKITOBY, Bernardin, 1997. "Rigidité normale, dévaluation et équilibre général intertemporel," Cahiers de recherche 9708, Universite de Montreal, Departement de sciences economiques.
  2. Rudiger Dornbusch, 1982. "Flexible Exchange Rates and Interdependence," NBER Working Papers 1035, National Bureau of Economic Research, Inc.

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