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Open Economy Macroeconomics: New Directions

Listed author(s):
  • Rudiger Dornbusch

The paper reviews the directions of research that offer important insights into open economy macroeconomic policy: pricing, waiting and expectations. The pricing discussion centers on the recognition that firms are price setters. This implies that industry shocks such as exchange rate movements or changes in commercial policy have effects on output and prices different from the standard model of a small country under perfect competition. Industrial organization considerations including market structure and product differentiation determine the impact of shocks on output and prices. Extensions of work on irreversible investment, drawing on the option literature, shows the value of waiting. In open economy macroeconomics this theory can be applied not only to questions of employment but also to such topics as the return of capital flight. The expectations literature is being extended to more ambitious stochastic models of policy. If agents extrapolate current disturbances, say in money, and expect a cumulative deviation of money from and initial path there will be large immediate effects of money innovations on exchange rates. These new models extend the Mundell- Fleming models by showing that even small changes in the growth rate of money can bring about large changes, and volatility, in exchange rates.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2372.

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Date of creation: Aug 1987
Publication status: published as Misalignment of Exchange Rates, T.R. Marston (ed), University of Chicago Press, 1988.
Handle: RePEc:nbr:nberwo:2372
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  1. Pindyck, Robert S, 1988. "Irreversible Investment, Capacity Choice, and the Value of the Firm," American Economic Review, American Economic Association, vol. 78(5), pages 969-985, December.
  2. Paul Krugman, 1986. "Pricing to Market when the Exchange Rate Changes," NBER Working Papers 1926, National Bureau of Economic Research, Inc.
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