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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. Richard Clarida & Jordi Gali, 1994. "Sources of Real Exchange Rate Fluctuations: How Important are Nominal Shocks?," NBER Working Papers 4658, National Bureau of Economic Research, Inc.
  2. Laurence Ball & David Romer, 1987. "Real Rigidities and the Non-Neutrality of Money," NBER Working Papers 2476, National Bureau of Economic Research, Inc.
  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. Kollmann, R., 1996. "The Exchange rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities: A Quantitative Investigation," Discussion Paper, Tilburg University, Center for Economic Research 1996-67, Tilburg University, Center for Economic Research.
  5. Lee, J. & Chinn, M.D., 1998. "The Current Account and the Real Exchange Rate: A Structural VAR Analysis of Major Currencies," Papers, California Irvine - School of Social Sciences 97-98-17, California Irvine - School of Social Sciences.
  6. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  7. Maurice Obstfeld and Kenneth Rogoff., 1995. "Exchange Rate Dynamics Redux," Center for International and Development Economics Research (CIDER) Working Papers, University of California at Berkeley C95-048, University of California at Berkeley.
  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., 1999. "The New Open Economy Macroeconomics: a Survey," CEPR Discussion Papers 2115, C.E.P.R. Discussion Papers.
  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, Elsevier, vol. 29(8), pages 1508-1528, December.
  3. Massimo Giuliodori, . "The Empirical Relevance of a basic sticky-price intertemporal model," Working Papers, Business School - Economics, University of Glasgow 2001_17, Business School - Economics, University of Glasgow.
  4. 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.

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