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Foreign Prices Shocks in a Small Open Economy

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  • Marias Halldor Gestsson

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    (School of Economics and Management, University of Aarhus, Denmark)

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    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.

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    Bibliographic Info

    Paper provided by School of Economics and Management, University of Aarhus in its series Economics Working Papers with number 2007-06.

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    Length: 34
    Date of creation: 01 Jun 2007
    Date of revision:
    Handle: RePEc:aah:aarhec:2007-06

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    Web page: http://www.econ.au.dk/afn/

    Related research

    Keywords: Open Economy Macroeconomics; New Open Economy Macro Models; small open economy; tradeables; exportables; importables; terms of trade; demand management; stabilization;

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    1. De Paoli, Bianca, 2009. "Monetary policy and welfare in a small open economy," Journal of International Economics, Elsevier, vol. 77(1), pages 11-22, February.
    2. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers 1131, C.E.P.R. Discussion Papers.
    3. Torben M. Andersen & Niels C. Beier, 2003. "Propagation of Nominal Shocks in Open Economies," Manchester School, University of Manchester, vol. 71(6), pages 567-592, December.
    4. Stephanie Schmitt-Grohe & Martin Uribe, 2002. "Closing Small Open Economy Models," NBER Working Papers 9270, National Bureau of Economic Research, Inc.
    5. Kollman, R., 1996. "The Exchange Rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities: A Quantitative Investigation," Cahiers de recherche 9614, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
    6. Lane, Philip R., 1997. "Inflation in open economies," Journal of International Economics, Elsevier, vol. 42(3-4), pages 327-347, May.
    7. Karen K. Lewis, 1999. "Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, American Economic Association, vol. 37(2), pages 571-608, June.
    8. Andersen, Torben M. & Holden, Steinar, 2002. "Stabilization policy in an open economy," Journal of Macroeconomics, Elsevier, vol. 24(3), pages 293-312, September.
    9. Faia, Ester & Monacelli, Tommaso, 2006. "Optimal Monetary Policy in a Small Open Economy with Home Bias," CEPR Discussion Papers 5522, C.E.P.R. Discussion Papers.
    10. Robert Miguel W. K. Kollman, 1997. "The Exchange Rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities," IMF Working Papers 97/7, International Monetary Fund.
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