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Current account and exchange rate dynamics

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  • Lilia Cavallari

Abstract

In the theoretical part of the paper, we analyze the positive and normative effects of a surprise monetary expansion in a small open economy characterized by imperfect competition and short-run price rigidity in the domestic sector. The temporary output boom fostered by the monetary expansion is shown to come at the cost of a permanent squeeze of the domestic sector. In general this affects welfare ambigously, since the welfare gain from the monetary expansion reduces as net foreign assets become smaller and eventually turns negative if the economy accumulates too large a debt towards the rest of the world. The empirical part of the paper provides evidence in favour of a crucial role of monetary shocks in current account fluctuations. This holds especially for the more open economies in the G7, namely the European countries and Canada.

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Bibliographic Info

Paper provided by University of Rome La Sapienza, Department of Public Economics in its series Working Papers with number 38.

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Length: 37
Date of creation: Nov 1999
Date of revision:
Handle: RePEc:sap:wpaper:wp38

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Keywords: small open economy; current account; monetary transmission mechanism; structural VAR.;

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References

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  1. Maurice Obstfeld & Kenneth Rogoff, 1994. "Exchange Rate Dynamics Redux," NBER Working Papers 4693, National Bureau of Economic Research, Inc.
  2. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  3. Elliott, Graham & Fatás, Antonio, 1995. "International Business Cycles and the Dynamics of the Current Account," CEPR Discussion Papers 1280, C.E.P.R. Discussion Papers.
  4. Ball, Laurence & Romer, David, 1990. "Real Rigidities and the Non-neutrality of Money," Review of Economic Studies, Wiley Blackwell, vol. 57(2), pages 183-203, April.
  5. Kollman, R., 1996. "The Exchange Rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities: a Quantitative Investigation," Cahiers de recherche 9614, Universite de Montreal, Departement de sciences economiques.
  6. Lee, J. & Chinn, M.D., 1998. "The Current Account and the Real Exchange Rate: A Structural VAR Analysis of Major Currencies," Papers 97-98-17, California Irvine - School of Social Sciences.
  7. Clarida, R. & Gali, J., 1993. "Sources of Real Exchange Rate Fluctuations: How Important are Nominal Shocks?," Discussion Papers 1993_25, Columbia University, Department of Economics.
  8. Lane, Philip R., 1997. "Inflation in open economies," Journal of International Economics, Elsevier, vol. 42(3-4), pages 327-347, May.
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Cited by:
  1. Lane, Philip R., 2001. "The new open economy macroeconomics: a survey," Journal of International Economics, Elsevier, vol. 54(2), pages 235-266, August.
  2. Darius, Reginald, 2010. "The macroeconomic effects of monetary and fiscal policy in a small open economy: Does the exchange rate regime matter?," Journal of International Money and Finance, Elsevier, vol. 29(8), pages 1508-1528, December.
  3. Thomas Lubik, 2003. "Industrial Structure and Monetary Policy in a Small Open Economy," Economics Working Paper Archive 493, The Johns Hopkins University,Department of Economics.
  4. Massimo Giuliodori, . "The Empirical Relevance of a basic sticky-price intertemporal model," Working Papers 2001_17, Business School - Economics, University of Glasgow.

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