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Understanding Macroeconomic Interdependence: Do We Really Need to Shut Off the Current Account?

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  • Fabio Ghironi

    ()
    (Boston College)

Abstract

This paper develops a small open economy, sticky-price model with a role for current account dynamics in the transmission of shocks. I solve the stationarity problem of incomplete markets, open economy models by adopting an overlapping-generations structure. I model nominal rigidity by assuming that firms face costs of output price inflation volatility. Markup dynamics affect labor demand and investment decisions. To illustrate the functioning of the model, I identify the home economy with Canada and analyze how a recession in the U.S. is transmitted to Canada under alternative inflation targeting rules. Stabilizing inflation (in consumer or producer prices) at a steady-state target in all periods results in a milder, but more persistent recession than a rule under which the interest rate reacts to inflation in a Taylor fashion. Markup dynamics and changes in asset holdings are central to this result.

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Bibliographic Info

Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 465.

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Length: 29 pages
Date of creation: 28 Apr 2000
Date of revision: 14 Aug 2003
Handle: RePEc:boc:bocoec:465

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Keywords: Current account; Markup; Nominal rigidity; Open economy macroeconomics; Stationarity;

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References

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Citations

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Cited by:
  1. Emmanuel K. K. Lartey, 2008. "Capital Inflows, Dutch Disease Effects, and Monetary Policy in a Small Open Economy," Review of International Economics, Wiley Blackwell, vol. 16(5), pages 971-989, November.
  2. Kumhof, Michael & Laxton, Douglas, 2013. "Fiscal deficits and current account deficits," Journal of Economic Dynamics and Control, Elsevier, vol. 37(10), pages 2062-2082.
  3. Ghironi, Fabio, 2006. "Macroeconomic interdependence under incomplete markets," Journal of International Economics, Elsevier, vol. 70(2), pages 428-450, December.
  4. Manmohan S. Kumar & Dennis P. J. Botman, 2006. "Fundamental Determinants of the Effects of Fiscal Policy," IMF Working Papers 06/72, International Monetary Fund.

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