New Open Economy Macroeconomics

The New Open Economy Macroeconomics refers to a vast body of literature embracing a new theoretical framework for policy analysis in open economy, with the goal of overcoming the limitations of the Mundell-Fleming model, while preserving the empirical wisdom and policy friendliness of traditional analysis. Starting in the early 1990s, NOEM contributions have developed general equilibrium models with imperfect competition and nominal rigidities, to reconsider conventional views on the transmission of monetary and exchange rate shocks; they have contributed to the design of optimal stabilization policies, identifying international dimensions of optimal monetary policy; they have raised issues in the desirability of international policy coordination.Open economy models; exchange rates; stabilization policy; Mundell-Fleming

Monetary Policy, Determinancy and Learnability in the Open Economy

We study how determinacy and learnability of global rational expectations equilibrium may be affected by monetary policy in a simple, two country, New Keynesian framework.The two blocks may be viewed as the U.S. and Europe, or as regions within the euro zone.We seek to understand how monetary policy choices may interact across borders to help or hinder the creation of a unique rational expectations equilibrium worldwide which can be learned by market participants. We study cases in which optimal policies are being pursued country by country as well as some forms of cooperation.We find that open economy considerations may alter conditions for determinacy and learnability relative to closed economy analyses, and that new concerns can arise in the analysis of classic topics such as the desirability of exchange rate targeting and monetary policy cooperation. Keywords: Indeterminacy, learning, monetary policy rules, new open economy macroeconomics, exchange rate regimes, second generation policy coordination.learning;monetairy policy;open economy;macroeconomics;exchange rate;indeterminacy;second generation policy coordination

Sources and Propagation Mechanims of Foreign Disturbances in Small Open Economies: A Dynamic Factor Analysis

This paper uses dynamic factor analysis to investigate the sources of foreign shocks and the propagation mechanism of these disturbances into two small open economies, Australia and Canada. Panels including a variety of foreign and domestic series for each country are used to estimate the factors. The specification of dynamics permits the computation of impulse responses which are used to suggest a structural interpretation of the factors. A small open economy model of the New Open Economy Macroeconomics is calibrated to contrast theoretical and empirical impulse responses. The results reveal that innovations in highly integrated equity markets are associated with comovements in investment which are crucial in explaining the cofluctuations in economic activity across countries. Therefore, the omission of traded capital goods in small open economy models represents an important shortcoming of theoretical frameworks in the literatureOpen Economy Macroeconomics Factor Analysis, Gibbs Sampling

Using a New Open Economy Macroeconomics model to make real nominal exchange rate forecasts

In this paper we undertake an out-of-sample evaluation of the ability of a model to forecast the Swedish Krona’s real and nominal effective exchange rate, using a cointegrating relation between the real exchange rate, relative output, terms of trade and net foreign assets (or alternatively the trade balance). The cointegrating relation is derived from a theoretical model of the New Open Economy Macroeconomics type. The forecasting performance of our estimated vector error correction model is quite good once the dynamics of the model have been augmented with an interest rate differential.New Open Economy Macroeconomics; real exchange rate; nominal exchange rate; forecasting

Trade Costs and the Open Macroeconomy

Trade costs are known to be a major obstacle to international economic integration. Following the approach of New Open Economy Macroeconomics, this paper explores the effects of international trade costs in a micro-founded general equilibrium model that also allows for pricing to market. Trade costs are shown to create an endogenous home bias in consumption and reduce cross-country consumption correlations. In addition, trade costs magnify exchange rate volatility in response to monetary shocks and typically turn a monetary expansion into a beggar-thy-neighbor policy. It is striking that trade costs generally lead to these results both under producer and local currency pricing.Trade Costs ; New Open Economy Macroeconomics ; Pricing to Market ; Exchange Rates ; Consumption Correlations

Teaching New Keynesian Open Economy Macroeconomics at the Intermediate Level

For the open economy the workhorse model in intermediate textbooks still is the Mundell-Fleming model, which basically extends the IS-LM model to open economy problems. The purpose of this paper is to present a simple New Keynesian model of the open economy, that introduces open economy considerations into the closed economy consensus version and that still allows for a simple and comprehensible analytical and graphical treatment. Above all, our model provides an efficient tool kit for the discussion of the costs and benefits of fixed and flexible exchange rates, which also was at the core of the Mundell-Fleming model. --open economy,inflation targeting,monetary policy rules,New Keynesian macroeconomics

A Theory of the Currency Denomination of International Trade

Nominal rigidities due to menu costs have become a standard element in closed economy macroeconomic modelling. The 'New Open Economy Macroeconomics' literature has investigated the implications of nominal rigidities in an open economy context and found that the currency in which prices are set has significant implications for exchange rate pass-through to import prices, the level of trade and net capital flows, and optimal monetary and exchange rate policy. While the literature has exogenously assumed in which currencies goods are priced, in this paper we solve for the equilibrium optimal pricing strategies of firms. We find that the higher the market share of an exporting country in an industry, and the more differentiated its goods, the more likely its exporters will price in the exporter's currency. Country size and the cyclicality of real wages play a role as well, but are empirically less important. We also show that when a set of countries forms a monetary union, the new currency is likely to be used more extensively in trade than the sum of the currencies it replaces.currency invoicing; new open economy macroeconomics

Transmission of nominal exchange rate changes to export prices and trade flows and implications for exchange rate policy

We discuss how the welfare ranking of fixed and flexible exchange rate regimes in a New Open Economy Macroeconomics model depends on the interplay between the degree of exchange rate pass-through and the elasticity of substitution between home and foreign goods. We identify combinations of these two parameters for which flexible and for which fixed exchange rates are superior with respect to welfare as measured by a representative household's utility level. We estimate the two parameters for six non-EMU European countries (Czech Republic, Hungary, Poland, Slovakia, Sweden, United Kingdom) using a heterogeneous dynamic panel approach. --Elasticity of substitution between home and foreign goods,exchange rate pass-through,exchange rate regime choice,expenditure switching effect,heterogeneous dynamic panel,New Open Economy Macroeconomics

Productive Government Spending, Welfare and Exchange Rate Dynamics

This study analyses the consequences of productive government spending on the international transmission of fiscal policy. A standard result in the new open economy macroeconomics literature is that a fiscal shock depreciates the exchange rate. I demonstrate that the response of the exchange rate depends on the productivity of government spending. If productivity is sufficiently high, a fiscal shock appreciates the exchange rate. It is also shown that the introduction of productive government spending increases both domestic and foreign welfare, when compared with the case where government spending is wasted. This is because productive government spending has a positive effect on private consumption in both countries in a two country NOEM model.New open economy macroeconomics, fiscal policy, international policy transmission

Endogenous Tradability andMacroeconomic Implications

This paper advocates a new way of thinking about goods trade in an open economy macro model. It develops a simple method for analyzing trade costs that are heterogeneous among a continuum of goods, and it explores how these costs determine the endogenous decision by a seller of whether to trade a good internationally. This way of thinking offers new insights into international market integration and the behavior of international relative prices. As one example, it provides a natural explanation for a prominent and controversial puzzle in international macroeconomics regarding the surprisingly low degree of volatility in the relative price of nontraded goods. Because tradedness is an endogenous decision, the good on the margin forms a link holding together the prices of traded and nontraded goods. The paper goes on to find that endogenizing trade has implications for other basic macroeconomic issues.endogenizing trade, open economy macroeconomics