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A Structuralist Model of the Small Open Economy in the Short, Medium and Long Run

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  • Hian Teck Hoon

    ()
    (School of Economics and Social Sciences, Singapore Management University)

  • Edmund S Phelps

    ()
    (Columbia University)

Abstract

Open-economy macroeconomics contains a monetary model in the Keynesian tradition that is deemed serviceable for analyzing the short run and a nonmonetary neoclassical model thought capable of handling the long run. But do the Keynesian and neoclassical models meet the challenges thrown out by the main events of the past few decades—the ’80s shock to Europe from the sharp increase of external real interest rates; the kind of speculative shock experienced in the U.S. and parts of northern Europe in the second half of the ’90s: the prospect of new industries emerging in the future with needs for new capital; and what may have been an important shock in the U.S.: the large Kennedy cut in income taxes in 1964? We first indicate that the effects of these shocks on the open economy are not well captured by either the standard Keynesian model or the standard neoclassical theory. Next we provide a careful development of a nonmonetary model of the equilibrium path of the real exchange rate, share price level,as well as natural output, employment and interest that contains “trading frictions” of the customer-market type. We then examine its implications for the above kinds of shocks not only over the medium run but over the short run and the long run as well. The structuralist model we develop also provides an explanation for the dollar’s weakening and accompanying decline in U.S. employment from early 2002 to late 2004 (and prediction of subsequent recovery) resting on belated apprehensions over the scheduled explosion over future decades of Medicare and Social Security outlays for the baby boomers and alarm over the large tax cuts enacted in spite of this prospect.

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Bibliographic Info

Paper provided by Singapore Management University, School of Economics in its series Working Papers with number 09-2005.

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Length: 49 pages
Date of creation: May 2005
Date of revision:
Publication status: Published in SMU Economics and Statistics Working Paper Series
Handle: RePEc:siu:wpaper:09-2005

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Keywords: structuralist model; share price; real exchange rate; employment;

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  1. Blanchard, Olivier & Giavazzi, Francesco & Sa, Filipa, 2005. "The US Current Account and the Dollar," CEPR Discussion Papers 4888, C.E.P.R. Discussion Papers.
  2. Hian Teck Hoon & Edmund S. Phelps, 2002. "A structuralist model of the small open economy in the short, medium and long run," Discussion Papers 0102-25, Columbia University, Department of Economics.
  3. Edmund Phelps & Gylfi Zoega, 2001. "Structural booms," Economic Policy, CEPR & CES & MSH, vol. 16(32), pages 83-126, 04.
  4. Lane, Philip R., 1999. "The New Open Economy Macroeconomics: a Survey," CEPR Discussion Papers 2115, C.E.P.R. Discussion Papers.
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  7. Obstfeld, Maurice & Rogoff, Kenneth, 2000. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," Center for International and Development Economics Research, Working Paper Series qt0sx02651, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
  8. Charles Engel, 1999. "Accounting for U.S. Real Exchange Rate Changes," Journal of Political Economy, University of Chicago Press, vol. 107(3), pages 507-538, June.
  9. Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022834, December.
  10. Gottfries, Nils, 1991. "Customer Markets, Credit Market Imperfections and Real Price Rigidity," Economica, London School of Economics and Political Science, vol. 58(231), pages 317-23, August.
  11. Rodriguez, Carlos Alfredo, 1979. "Short- and Long-Run Effects of Monetary and Fiscal Policies under Flexible Exchange Rates and Perfect Capital Mobility," American Economic Review, American Economic Association, vol. 69(1), pages 176-82, March.
  12. Paul Krugman, 1986. "Pricing to Market when the Exchange Rate Changes," NBER Working Papers 1926, National Bureau of Economic Research, Inc.
  13. Malinvaud,Edmond, 1994. "Diagnosing Unemployment," Cambridge Books, Cambridge University Press, number 9780521445337, April.
  14. Sven W. Arndt & J. David Richardson, 1987. "Real-Financial Linkages Among Open Economies," NBER Working Papers 2230, National Bureau of Economic Research, Inc.
  15. Phelps, Edmund S, 1988. "A Working Model of Slump and Recovery from Disturbances to Capital-Goods Demand in an Open Nonmonetary Economy," American Economic Review, American Economic Association, vol. 78(2), pages 346-50, May.
  16. Edmund S. Phelps & Hian Teck Hoon & Gylfi Zoega, 2004. "The Structuralist Perspective on Real Exchange Rate, Share Price Level and Employment Path: What Room is Left for Money?," Working Papers 05-2004, Singapore Management University, School of Economics.
  17. Hoon, H.T. & Phelps, E., 1990. "Macroeconomics Shocks In Dynamized Models Of The Natural Rate Of Unemployment," Discussion Papers 1990_36, Columbia University, Department of Economics.
  18. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers 1131, C.E.P.R. Discussion Papers.
  19. Hall, Robert E, 1988. "The Relation between Price and Marginal Cost in U.S. Industry," Journal of Political Economy, University of Chicago Press, vol. 96(5), pages 921-47, October.
  20. Robert A. Mundell, 1962. "The Appropriate Use of Monetary and Fiscal Policy for Internal and External Stability," IMF Staff Papers, Palgrave Macmillan, vol. 9(1), pages 70-79, March.
  21. João Ricardo Faria & Miguel León-Ledesma, 2000. "The Intertemporal Substitution Model of Labor Supply in an Open Economy," Studies in Economics 0009, Department of Economics, University of Kent.
  22. Hoon, Hian Teck & Phelps, Edmund S, 1992. "Macroeconomic Shocks in a Dynamized Model of the Natural Rate of Unemployment," American Economic Review, American Economic Association, vol. 82(4), pages 889-900, September.
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Cited by:
  1. Hian Teck Hoon & Edmund S. Phelps, 2002. "A structuralist model of the small open economy in the short, medium and long run," Discussion Papers 0102-25, Columbia University, Department of Economics.
  2. Faria, Joao Ricardo & Leon-Ledesma, Miguel A., 2005. "Real exchange rate and employment performance in an open economy," Research in Economics, Elsevier, vol. 59(1), pages 67-80, March.

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