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New Directions for Stochastic Open Economy Models

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  • Obstfeld, Maurice
  • Rogoff, Kenneth

Abstract

The paper develops a simple stochastic new open economy macroeconomic model based on sticky nominal wages. Explicit solution of the wage-setting problem under uncertainty allows one to analyze the effects of the monetary regime on welfare, expected output, and the expected terms of trade. Despite the potential interplay between imperfections due to sticky wages and monopoly, the optimal monetary policy rule has a closed-form solution. To motivate our model, we show that observed correlations between terms of trade and exchange rates are more consistent with our traditional assumptions about nominal rigidities than with a popular alternative based on local-currency pricing.

Suggested Citation

  • Obstfeld, Maurice & Rogoff, Kenneth, 1999. "New Directions for Stochastic Open Economy Models," Center for International and Development Economics Research, Working Paper Series qt5pf7g8sh, Center for International and Development Economics Research, Institute for Business and Economic Research, UC Berkeley.
  • Handle: RePEc:cdl:ciders:qt5pf7g8sh
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    References listed on IDEAS

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    Keywords

    new open-economy macroeconomics; currency risk; pricing to market; international policy transmission; optimal monetary policy;

    JEL classification:

    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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