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The Open Economy: Implications for Monetary and Fiscal Policy

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  • Rudiger Dornbusch
  • Stanley Fischer

Abstract

The exchange rate has by 1984 become as central to United States economic policy discussions as it has long been in the rest of the world. In this paper we show how the standard closed-economy macroeconomic model -- the Phillips curve augmented IS-LM analysis -- has to be modified for the United States to take account of the economy's international interactions. The only key structural equation that goes unamended is the money demand equation. Foreign prices,foreign activity, and foreign asset yields in the goods and asset markets appearas important determinants of domestic activity, prices, and interest rates. We show that international interactions exert an important effect on the manner in which monetary and fiscal policies operate. The Phillips curve is much steeper under flexible than fixed interest rates. A tight money policy leads to appreciation under flexible rates, and thus to more rapid disinflation. Fiscal expansion, because it induces currency appreciation, is less inflationary under flexible than fixed exchange rates, but it also involves more crowding out. We show that these effects are in practice significantly large for the United States economy.

Suggested Citation

  • Rudiger Dornbusch & Stanley Fischer, 1984. "The Open Economy: Implications for Monetary and Fiscal Policy," NBER Working Papers 1422, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:1422
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    1. repec:kap:iaecre:v:14:y:2008:i:3:p:280-290 is not listed on IDEAS
    2. Maozu Lu & Zhichao Zhang, 2003. "Exchange rate reform and its inflationary consequences: an empirical analysis for China," Applied Economics, Taylor & Francis Journals, vol. 35(2), pages 189-199.
    3. Catherine Bruno, 1995. "L'Allemagne joue-t-elle le rôle de locomotive vis-à-vis de la France ?," Revue de l'OFCE, Programme National Persée, vol. 53(1), pages 165-195.
    4. Crucini, Mario J. & Kahn, James, 1996. "Tariffs and aggregate economic activity: Lessons from the Great Depression," Journal of Monetary Economics, Elsevier, vol. 38(3), pages 427-467, December.
    5. Bordo, Michael D., 1996. "Log-rolling, partisanship, and economic interest in the passage of the Hawley-Smoot tariff A comment," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 45(1), pages 201-205, December.
    6. Jaime R. Marquez, 1995. "A century of trade elasticities for Canada, Japan, and the United States," International Finance Discussion Papers 531, Board of Governors of the Federal Reserve System (U.S.).
    7. Lucas Papademos, 2005. "Macroeconomic theory and monetary policy: the contributions of Franco Modigliani and the ongoing debate," Banca Nazionale del Lavoro Quarterly Review, Banca Nazionale del Lavoro, vol. 58(233-234), pages 187-214.
    8. Jaime R. Marquez, 1994. "The constancy of illusions or the illusion of constancies: income and price elasticities for U.S. imports, 1890-1992," International Finance Discussion Papers 475, Board of Governors of the Federal Reserve System (U.S.).
    9. Aldo Levy & Larry Bensimhon, 2009. "Crises financières : rôle de l'information et mimétisme légal," Post-Print halshs-00593988, HAL.
    10. Lucas Papademos, 2005. "Macroeconomic theory and monetary policy: the contributions of Franco Modigliani and the ongoing debate," BNL Quarterly Review, Banca Nazionale del Lavoro, vol. 58(233-234), pages 187-214.

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