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Money and the Open Economy Business Cycle: A Flexible Price Model

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  • Robert P. Flood
  • Robert J. Hodrick

Abstract

This paper develops an open-economy model of the business cycle. The nominal prices in the model are flexible and monetary nonneutrality is developed using information confusion about the sources of disturbances to demand coupled with differential persistence of demand shocks. Firms use inventories to smooth their production, and consumers follow a stochastic permanent income expenditure function. The major implication of the model is that unperceived monetary disturbances improve the terms of trade and increase real output in contrast to sticky price models in which the terms of trade deteriorates. This implication of the model is examined empirically.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1967.

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Date of creation: Jun 1986
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Handle: RePEc:nbr:nberwo:1967

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  1. Boschen, John F. & Grossman, Herschel I., 1982. "Tests of equilibrium macroeconomics using contemporaneous monetary data," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 309-333.
  2. Robert J. Barro & Zvi Hercowitz, 1979. "Money Stock Revisions and Unanticipated Money Growth," NBER Working Papers 0329, National Bureau of Economic Research, Inc.
  3. Alan C. Stockman & Ai Tee Koh, 1984. "Open-Economy Implications of Two Models of Business Fluctuations," NBER Working Papers 1317, National Bureau of Economic Research, Inc.
  4. Alan S. Blinder, 1981. "Retail Inventory Behavior and Business Fluctuations," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(2), pages 443-520.
  5. 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.
  6. McCallum, Bennett T, 1979. "On the Observational Inequivalence of Classical and Keynesian Models," Journal of Political Economy, University of Chicago Press, vol. 87(2), pages 395-402, April.
  7. Blanchard, Olivier J, 1983. "The Production and Inventory Behavior of the American Automobile Industry," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 365-400, June.
  8. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April.
  9. Flood, Robert P, 1979. "Capital Mobility and the Choice of Exchange Rate System," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 20(2), pages 405-16, June.
  10. Blinder, Alan S. & Fischer, Stanley, 1981. "Inventories, rational expectations, and the business cycle," Journal of Monetary Economics, Elsevier, vol. 8(3), pages 277-304.
  11. Joshua Aizenman & Jacob A. Frenkel, 1984. "Optimal Wage Indexation, Foreign-Exchange Intervention and Monetary Policy," NBER Working Papers 1329, National Bureau of Economic Research, Inc.
  12. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  13. Mussa, Michael, 1982. "A Model of Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 74-104, February.
  14. Flood, Robert P & Marion, Nancy Peregrim, 1982. "The Transmission of Disturbances under Alternative Exchange-Rate Regimes with Optimal Indexing," The Quarterly Journal of Economics, MIT Press, vol. 97(1), pages 43-66, February.
  15. Richard C. Marston, 1982. "Wages, Relative Prices and the Choice between Fixed and Flexible Exchange Rates," Canadian Journal of Economics, Canadian Economics Association, vol. 15(1), pages 87-103, February.
  16. Brunner, Karl & Cukierman, Alex & Meltzer, Allan H., 1983. "Money and economic activity, inventories and business cycles," Journal of Monetary Economics, Elsevier, vol. 11(3), pages 281-319.
  17. Amihud, Yakov & Mendelson, Haim, 1982. "The output-inflation relationship : An inventory-adjustment approach," Journal of Monetary Economics, Elsevier, vol. 9(2), pages 163-184.
  18. Turnovsky, Stephen J, 1976. "The Relative Stability of Alternative Exchange Rate Systems in the Presence of Random Disturbances," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 8(1), pages 29-50, February.
  19. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  20. 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.
  21. Brunner, Karl & Meltzer, Allan H., 1977. "Stabilization of the domestic and international economy," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 5(1), pages 1-6, January.
  22. Weber, Warren E, 1981. "Output Variability under Monetary Policy and Exchange Rate Rules," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 733-51, August.
  23. Flood, Robert P & Hodrick, Robert J, 1985. "Optimal Price and Inventory Adjustment in an Open-Economy Model of the Business Cycle," The Quarterly Journal of Economics, MIT Press, vol. 100(5), pages 887-914, Supp..
  24. Saidi, Nasser H, 1980. "Fluctuating Exchange Rates and the International Transmission of Economic Disturbances," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 12(4), pages 575-91, November.
  25. Taylor, John B, 1979. "Estimation and Control of a Macroeconomic Model with Rational Expectations," Econometrica, Econometric Society, vol. 47(5), pages 1267-86, September.
  26. Flavin, Marjorie A, 1981. "The Adjustment of Consumption to Changing Expectations about Future Income," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 974-1009, October.
  27. Richard C. Marston, 1981. "Wages, Relative Prices, and the Choice between Fixed and Flexible Exchange Rates," NBER Working Papers 0793, National Bureau of Economic Research, Inc.
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