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A Small Open Economy with Staggered Wage Setting and Intertemporal Optimization: The Basic Analytics

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  • John Fender

    (University of Birmingham)

  • Neil Rankin

Abstract

We develop a model of a small open economy with optimizing, infinitely lived agents. They have monopoly power over the price of their labour, and wage setting is staggered. We consider the effects of an unanticipated increase in the money supply. In all cases, the exchange rate depreciates immediately to its long-run value with no overshooting. With unitary elasticity of substitution in preferences between home and foreign goods, output rises instantaneously but gradually returns to its initial value in the long run. Trade remains balanced at all times. With an elasticity of substitution above unity, there is a trade surplus in the short run and a deficit in the long run, as permanently higher net foreign assets are accumulated. Convergence to the steady state is faster, and thus output persistence is smaller. With unitary elasticity the dynamics are the same as in an equivalent closed economy, so, to the extent that an elasticity greater than one is plausible for an open economy, we conclude that openness reduces output persistence. Copyright Blackwell Publishing Ltd and The Victoria University of Manchester, 2003.

Suggested Citation

  • John Fender & Neil Rankin, 2003. "A Small Open Economy with Staggered Wage Setting and Intertemporal Optimization: The Basic Analytics," Manchester School, University of Manchester, vol. 71(4), pages 396-416, July.
  • Handle: RePEc:bla:manchs:v:71:y:2003:i:4:p:396-416
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    References listed on IDEAS

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    Cited by:

    1. John Fender & Neil Rankin, "undated". "On the (Non)Equivalence of Money- and Exchange-Rate-Based Disinflation," EcoMod2006 272100026, EcoMod.
    2. Santiago L.E. Acosta Ormaechea, 2007. "A Small Open Economy Model with Currency Mismactches and a Financial Accelerator Mechanism," DEGIT Conference Papers c012_035, DEGIT, Dynamics, Economic Growth, and International Trade.

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