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Optimal Price and Inventory Adjustment in an Open-Economy Model of the Business Cycle

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  • Flood, Robert P
  • Hodrick, Robert J

Abstract

This paper develops an open-economy macroeconomic model which can be used to interpret the observed fluctuations in output, inventories,prices,and exchange rates in the medium-sized economies of the world. The model is consistent with the major empirical regularities that have been discovered in studies of business cycles as closed-economy phenomena and in empirical studies of prices and exchange rates. The empirical regularities are (i) changes in the nominal money supply cause real output fluctuations, (ii) deviations of output from a "natural rate" show persistence, (iii)exchangerates are more volatile than nominal prices of goods, and (iv) depreciations of the currency coincide with deteriorations of the terms of trade. A controversial aspect of the model is that only unperceived money has real effects. The channel through which these effects arise involves a misperception by rational maximizing firms of the true demand that they will face after having set prices. The firms learn about their environment from equilibrium asset prices, and the dynamics of the model reflect the optimal response of inventory-holding firms rather than ad hoc price dynamics.

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Bibliographic Info

Article provided by MIT Press in its journal Quarterly Journal of Economics.

Volume (Year): 100 (1985)
Issue (Month): 5 (Supp.)
Pages: 887-914

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Handle: RePEc:tpr:qjecon:v:100:y:1985:i:5:p:887-914

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References

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  1. Ray C. Fair, 1978. "An Analysis of the Accuracy of Four Macroeconometric Models," Cowles Foundation Discussion Papers 492, Cowles Foundation for Research in Economics, Yale University.
  2. Makin, John H, 1982. "Anticipated Money, Inflation Uncertainty and Real Economic Activity," The Review of Economics and Statistics, MIT Press, vol. 64(1), pages 126-34, February.
  3. John H. Makin, 1982. "Anticipated Money, Inflation Uncertainty, and Real Economic Activity," NBER Working Papers 0760, National Bureau of Economic Research, Inc.
  4. Kohn, Meir, 1981. "In Defense of the Finance Constraint," Economic Inquiry, Western Economic Association International, vol. 19(2), pages 177-95, April.
  5. Amihud, Yakov & Mendelson, Haim, 1982. "The output-inflation relationship : An inventory-adjustment approach," Journal of Monetary Economics, Elsevier, vol. 9(2), pages 163-184.
  6. Robert J. Barro & Mark Rush, 1979. "Unanticipated Money and Economic Activity," NBER Working Papers 0339, National Bureau of Economic Research, Inc.
  7. Alan S. Blinder, 1983. "Inventories and Sticky Prices: More on the Microfoundations of Macroeconomics," NBER Working Papers 0620, National Bureau of Economic Research, Inc.
  8. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  9. Frenkel, Jacob A & Mussa, Michael L, 1980. "The Efficiency of Foreign Exchange Markets and Measures of Turbulence," American Economic Review, American Economic Association, vol. 70(2), pages 374-81, May.
  10. Canzoneri, Matthew B & Henderson, Dale W & Rogoff, Kenneth S, 1983. "The Information Content of the Interest Rate and Optimal Monetary Policy," The Quarterly Journal of Economics, MIT Press, vol. 98(4), pages 545-66, November.
  11. Mishkin, Frederic S, 1982. "Does Anticipated Monetary Policy Matter? An Econometric Investigation," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 22-51, February.
  12. Bennett T. McCallum, 1982. "Macroeconomics after a decade of rational expectations : some critical issues," Economic Review, Federal Reserve Bank of Richmond, issue Nov, pages 3-12.
  13. Sargent, Thomas J, 1976. "A Classical Macroeconometric Model for the United States," Journal of Political Economy, University of Chicago Press, vol. 84(2), pages 207-37, April.
  14. King, Robert G, 1982. "Monetary Policy and the Information Content of Prices," Journal of Political Economy, University of Chicago Press, vol. 90(2), pages 247-79, April.
  15. Mussa, Michael, 1979. "Empirical regularities in the behavior of exchange rates and theories of the foreign exchange market," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 11(1), pages 9-57, January.
  16. Martin Feldstein & Alan Auerbach, 1976. "Inventory Behavior in Durable-Goods Manufacturing: The Target-Adjustment Model," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 7(2), pages 351-408.
  17. Michael C. Lovell, 1959. "Manufacturers' Inventories, Sales Expectations, and the Acceleration Principle," Cowles Foundation Discussion Papers 86, Cowles Foundation for Research in Economics, Yale University.
  18. Eichenbaum, Martin, 1983. "A rational expectations equilibrium model of inventories of finished goods and employment," Journal of Monetary Economics, Elsevier, vol. 12(2), pages 259-277.
  19. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April.
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Cited by:
  1. Joshua Aizenman, 1989. "Monopolistic Competition, Relative Prices and Output Adjustment in the Open Economy," NBER Working Papers 1787, National Bureau of Economic Research, Inc.
  2. Joshua Aizenman, 1990. "Market Power and Exchange Rate Adjustment in the Presence of Quotas," NBER Working Papers 2370, National Bureau of Economic Research, Inc.
  3. Michael Kiley, 2002. "The lead of output over inflation in sticky price models," Economics Bulletin, AccessEcon, vol. 5(5), pages 1-7.
  4. Bennett T. McCallum, 1995. "A Semi-Classical Model of Price Level Adjustment," NBER Working Papers 4706, National Bureau of Economic Research, Inc.
  5. Joshua Aizenman, 1985. "Monopolistic Competition and Deviations from PPP," NBER Working Papers 1552, National Bureau of Economic Research, Inc.
  6. Robert P. Flood & Robert J. Hodrick, 1986. "Money and the Open Economy Business Cycle: A Flexible Price Model," NBER Working Papers 1967, National Bureau of Economic Research, Inc.
  7. Maurice Obstfeld & Alan C. Stockman, 1985. "Exchange-Rate Dynamics," NBER Working Papers 1230, National Bureau of Economic Research, Inc.
  8. repec:ebl:ecbull:v:5:y:2002:i:5:p:1-7 is not listed on IDEAS

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