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Foreign Prices Shocks in a Small Open Economy

  • Marias Halldor Gestsson

    ()

    (School of Economics and Management, University of Aarhus, Denmark)

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    Countries specialize in producing goods that they have comparative advantages in producing. This results in a country exporting some goods while it imports other. Hence, there is a reason to expect that changes in the prices of these goods have consid- erable economic e¤ect and that demand management can be used to improve welfare following such changes. This paper analyses this using a New Open Economy Macro (NOEM) model of a small open economy. Among others, the results indicate that, in a small open economy, a terms of trade appreciation results in increased consumption, labor use and output on impact while consumption increases but labor use and output decrease in future time periods. The results also indicate that the vulnerability of an economy towards such shocks is negatively related to its size. Finally, the results indicate that there exists a welfare improving demand management policy following a terms of trade shock.

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    File URL: ftp://ftp.econ.au.dk/afn/wp/07/wp07_06.pdf
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    Paper provided by School of Economics and Management, University of Aarhus in its series Economics Working Papers with number 2007-06.

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    Length: 34
    Date of creation: 01 Jun 2007
    Date of revision:
    Handle: RePEc:aah:aarhec:2007-06
    Contact details of provider: Web page: http://www.econ.au.dk/afn/

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    1. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Closing Small Open Economy Models," Departmental Working Papers 200115, Rutgers University, Department of Economics.
    2. Kollman, R., 1996. "The Exchange Rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities: A Quantitative Investigation," Cahiers de recherche 9614, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
    3. Torben M. Andersen & Niels C. Beier, 2003. "Propagation of Nominal Shocks in Open Economies," Manchester School, University of Manchester, vol. 71(6), pages 567-592, December.
    4. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers 1131, C.E.P.R. Discussion Papers.
    5. Karen K. Lewis, 1999. "Trying to Explain Home Bias in Equities and Consumption," Journal of Economic Literature, American Economic Association, vol. 37(2), pages 571-608, June.
    6. Andersen, Torben M. & Holden, Steinar, 2002. "Stabilization policy in an open economy," Journal of Macroeconomics, Elsevier, vol. 24(3), pages 293-312, September.
    7. Ester Faia & Tommaso Monacelli, 2006. "Optimal Monetary Policy in a Small Open Economy with Home Bias," Computing in Economics and Finance 2006 521, Society for Computational Economics.
    8. Bianca De Paoli, 2004. "Monetary Policy and Welfare in a Small Open Economy," CEP Discussion Papers dp0639, Centre for Economic Performance, LSE.
    9. Lane, Philip R., 1997. "Inflation in open economies," Journal of International Economics, Elsevier, vol. 42(3-4), pages 327-347, May.
    10. Robert Miguel W. K. Kollman, 1997. "The Exchange Rate in a Dynamic-Optimizing Current Account Model with Nominal Rigidities; A Quantitative Investigation," IMF Working Papers 97/7, International Monetary Fund.
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