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Monetary Policy, Currency Unions and Open Economy Macrodynamics

  • Toichiro Asada
  • Peter Flaschel
  • Gang Gong
  • Willi Semmler

In this paper we extend an integrated closed-economy macrodynamic model to account for a large open economy in a currency area with fixed nominal exchange rates between the currencies. The major issues are the effectiveness and macrodynamic effects of monetary policy for countries in a pegged or fixed exchange rate system. The model assumes a leader-follower relationship as in Kenen (2002) where the dominant country pursues a monetary policy and the other countries adjust. We explore the effect of two policy rules - the monetary authority targeting the money supply or interest rate. The model augments Keynesian AS-AD growth dynamics by goods market disequilibrium, price and quantity adjustment processes and income distribution dynamics and is completely specified with respect budget and behavioral equations. The steady state of the resulting 7D dynamical system is asymptotically stable for sluggish responses to labor and goods market imbalances, if the Keynes-effect is strong and sales expectations sufficiently fast. Increasing adjustment speeds for wages, prices, inflationary expectations or inventories however implies loss of local stability by way of Hopf-bifurcations. Monetary policy rules augment the dimension of the considered dynamics by one (interest rate rule) or two (money supply rule) and may stabilize the economy to some extent if the adjustment speeds in these rules are chosen with care. Yet, behavioral nonlinearities are needed in addition to ensure economic viability over a larger range of the parameter values of the model.

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File URL: http://ces.utia.cas.cz/bulletin/index.php/bulletin/article/view/124
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Article provided by The Czech Econometric Society in its journal Bulletin of the Czech Econometric Society.

Volume (Year): 10 (2003)
Issue (Month): 19 ()
Pages:

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Handle: RePEc:czx:journl:v:10:y:2003:i:19:id:124
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  1. repec:cup:cbooks:9780521643511 is not listed on IDEAS
  2. Franke, Reiner, 1996. "A Metzlerian model of inventory growth cycles," Structural Change and Economic Dynamics, Elsevier, vol. 7(2), pages 243-262, June.
  3. Franke, Reiner & Lux, Thomas, 1993. " Adaptive Expectations and Perfect Foresight in a Nonlinear Metzlerian Model of the Inventory Cycle," Scandinavian Journal of Economics, Wiley Blackwell, vol. 95(3), pages 355-63.
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