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Current account and exchange rate dynamics

  • Lilia Cavallari

In the theoretical part of the paper, we analyze the positive and normative effects of a surprise monetary expansion in a small open economy characterized by imperfect competition and short-run price rigidity in the domestic sector. The temporary output boom fostered by the monetary expansion is shown to come at the cost of a permanent squeeze of the domestic sector. In general this affects welfare ambigously, since the welfare gain from the monetary expansion reduces as net foreign assets become smaller and eventually turns negative if the economy accumulates too large a debt towards the rest of the world. The empirical part of the paper provides evidence in favour of a crucial role of monetary shocks in current account fluctuations. This holds especially for the more open economies in the G7, namely the European countries and Canada.

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Paper provided by University of Rome La Sapienza, Department of Public Economics in its series Working Papers with number 38.

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Length: 37
Date of creation: Nov 1999
Date of revision:
Handle: RePEc:sap:wpaper:wp38
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  1. Jordi Galí & Richard Clarida, 1993. "Sources of real exchage rate fluctuations: How important are nominal shocks?," Economics Working Papers 66, Department of Economics and Business, Universitat Pompeu Fabra, revised Jan 1994.
  2. Lars E.O. Svensson & Sweder van Wijnbergen, 1987. "Excess Capacity, Monopolistic Competition, and International Transmission of Monetary Disturbances," NBER Working Papers 2262, National Bureau of Economic Research, Inc.
  3. Maurice Obstfeld and Kenneth Rogoff., 1995. "Exchange Rate Dynamics Redux," Center for International and Development Economics Research (CIDER) Working Papers C95-048, University of California at Berkeley.
  4. Jaewoo Lee & Menzie D. Chinn, 1998. "The Current Account and the Real Exchange Rate: A Structural VAR Analysis of Major Currencies," NBER Working Papers 6495, National Bureau of Economic Research, Inc.
  5. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  6. Laurence Ball & David Romer, 1987. "Real Rigidities and the Non-Neutrality of Money," NBER Working Papers 2476, National Bureau of Economic Research, Inc.
  7. Lane, Philip R., 1997. "Inflation in open economies," Journal of International Economics, Elsevier, vol. 42(3-4), pages 327-347, May.
  8. Elliott, Graham & Fatas, Antonio, 1996. "International business cycles and the dynamics of the current account," European Economic Review, Elsevier, vol. 40(2), pages 361-387, February.
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