Wages, the Terms of Trade, and the Exchange Rate Regime

This paper analyzes a two-commodity short-run macroeconomic model under fixed and flexible exchange rates. Goods are disaggregated into imports and exports. Both are consumed domestically, but only the latter is produced at home. While imports are available in international markets at a fixed price, relative size matters in that the country’s specialized export good faces a less than infinitely elastic foreign demand. The seemingly natural disaggregation used here yields a model that is better suited than traditional models for the analysis of such problems as imported inflation and for flexible exchange rates. Also, the terms of trade is explicit and hence easily distinguished from the exchange rate, and the model can be used to illustrate the relationship between the elasticities, absorption and monetary approaches. A common theme in the contemporary literature on flexible exchange rates is that the exchange rate is determined by financial portfolio decisions; a key assumption implicit in such models is that changes in the exchange rate have no real effects, even in the short run. The present approach imposes more structure on the problem by introducing possible short-run real effects of the exchange rate due to less than infinitely elastic export demand and explicitly specified domestic supply. The stability and comparative static properties of the model are shown to depend crucially on the specification of aggregate supply and the behavior of wages, in addition to relative size, and it is surprising that so little attention has been paid in the literature to this issue

Technology, Trade and Factor Mobility

The well-known factor price equalization theorem is often invoked to provide trade theorists with justification for the conventional assumption of complete international immobility of factors of production. If conditions of the theorem are satisfied, and free trade does in fact give rise to the equalization of factor returns, then it is inconsequential in which country production takes place. Mundell's original analysis then brings us full circle to the "commodity price equalization theorem". If the conditions of the factor price equalization theorem are met, but a tariff on trade is imposed, then factor mobility can replace trade in establishing productive efficiency. Recent work by Jones and Kemp have analysed further the implications of introducing factor mobility and in particular capital mobility into the analysis of international trade. However, these have concentrated on generating optimum tariff and tax( on capital services) formulae for the individual country trying to maximize its own welfare. The present paper is more in the tradition of the Mundell analysis in that we are more concerned with world efficiency in production--that is, in maximizing potential world welfare.

More on Growth and the Balance of Payments: The Adjustment Process

The effect of an economy's growth on its balance of payments has been a subject which has received a good deal of attention in the recent literature in international economics. Much of this attention derives from general dissatisfaction with the theoretical and empirical aspects of the standard Keynesian analysis which argues that, via the existence of a positive marginal propensity to import, growth in a country's income will lead to an increase in imports. Hence, the argument proceeds, for given exports, growth leads to a deterioration in the balance of payments. As a result, we have developed the "monetary approach" to growth and the balance of payments emphasizing the role of asset market equilibrium. Further we have demonstrated this approach to be capable of yielding insights into the short-run or transitional effects on the balance of payments of various exogenous disturbances. It is hoped that the examples provided in the following article will highlight the importance of considering impact effects and adjustment processes when looking at balance of payments or any other macroeconomic phenomena, and that future research will reflect such considerations.

Aspect of Asset Behavior in Continuous Time Macroeconomic Models

It is the purpose of the present paper to consider, in the context of a continuous time macroeconomic model, how the explicit consideration of the existence of adjustment costs(including foregone consumption) which preclude instantaneous changes in the level of certain stock variables modifies our interpretation of the 'conventional' macro-economic analyses. In the following section of the paper, we consider the interpretations of asset demand functions and of the traditional stock constraint. Attention is given to the implications of different possible specifications of adjustment costs-in particular, two specifications which might be thought to correspond to the theory of the individual asset holder and to the theory of the economy as a whole will be treated. The distinction is drawn between positions of short run, or transitory, equilibrium characterized by flow equilibrium in assets, and positions of long run, or full, equilibrium characterized in addition by(long-run) stock equilibrium. Implications for the specification of asset demand functions are considered. Finally, implications for the dynamics of adjustment from one position of full equilibrium to another will be derived.

Short-Run Adjustment in Models of Money and Growth

Keynes-Wicksell models are one of the approaches to monetary growth theory. The essential features of the KW models are independent investment savings decisions, and the explicit representation of a price equation in which prices rise only in response to excess demand in the goods market. Then, from Walras' law, corresponding to the excess demand in the goods market there must be excess flow supply in the money market. Jerome Stein then treats the special case where the flow excess supply of money corresponds to a stock excess supply of money, and hence prices move in response to stock disequilibrium in the asset markets. It is argued here that this possibility of stock disequilibrium is in fact the crucial point of departure from the neoclassical scenario, and by considering the implications of stock disequilibrium on the demand behavior of the economic agents, the KW and neoclassical approaches are more easily reconcilable. Specifically,adjustment costs are explicitly introduced to explain the stock disequilibrium, and wealth holders act to adjust their asset holdings in an optimum manner along an equilibrium path. That is, the flows dominate in the short run, and flow equilibrium is sustained. Long run equilibrium is characterized by stock equilibrium in addition to flow equilibrium. It is the purpose of this note to explicitly analyse the flow aspects of a simple model which reflects the essential details of that used by Stein and to derive simple dynamics of price change consistent with possible stock disequilibrium.

An Integrated Model of Household Flow-of-Funds Allocations

This paper extends the multivariate stock-adjustment model commonly used in empirical studies of portfolio behavior in order to analyze the complete set of flow allocation decisions made by households (including consumption, expenditures on durables and houses, and various financial aggregates). The model is then confronted with quarterly household sector data from the United States Flow of Funds Accounts for the period 1954 to 1975. Besides presenting OLS estimates, we test parameter restrictions suggested by our theoretical structure; the data supports the view that the explanatory power of the model is enhanced by allowing non-zero cross-effects on interest rates and lagged stocks, and by the integration of real and financial decisions. While these results are encouraging, the specification requires a large number of independent variables. This leads, in many cases, to rather poor determination of a number of coefficients. We therefore combine with the data some inexact subjective information about the coefficients, using the Theil-Goldberger mixed estimation technique. The OLS estimates and the mixed estimates are then compared by examining the forecasting accuracy of the model in- and out-of-sample. Overall the model performs very well, and the simulation results confirm that inclusion of prior information is of considerable value for forecasting purposes. Since the publication of William Brainard and James Tobin’s pioneering paper, “Pitfalls in Financial Model Building,” the multivariate stock-adjustment model has been widely used to study dynamic portfolio adjustment. The framework which they developed is especially useful for analyzing a given sector’s allocation of a predetermined aggregate among competing alternatives; when dealing with the household sector most applications (including their own) have specified wealth as a predetermined aggregate which, in turn, was allocated to various assets and liabilities. The purpose of the present paper is to use an extended version of the Pitfalls model to examine in an integrated manner the household sector’s allocation of income to financial and real expenditures for the United States from 1954 to the present. The plan of the paper is as follows. In Section I we outline our basic theoretical framework, explain its motivation, and relate our approach to other recent flow-of-funds models. Then in Section II we describe the data and present ordinary least squares estimates of the model; in addition, we test for the “asset composition effect” which is central to our particular extension of the Pitfalls model. In Section III we use Brainard and Gary Smith’s adaptation of the Theil-Goldberger mixed estimation technique to combine subjective prior information about the coefficients with that embodied in the data. We further examine in Section IV both the model and the value of our a priori beliefs by performing in-sample and out-of-sample dynamic simulations. Finally, conclusions are drawn in Section V

International Differences in Response to Common External Shocks: The Role of Purchasing Power Parity

Published in connection with a visit at the IIE

Oil, Disinflation, and Export Competitiveness: A Model of the "Dutch Disease"

This paper examines three possible sources of "de-industrialization" in an open economy: monetary disinflation, an increase in the international price of oil, and a 'domestic oil discovery. The analysis is conducted using a model which incorporates different speeds of adjustment in goods and asset markets; domestic goods prices respond only sluggishly to excess demand while the exchange rate (and hence the price of imported goods) adjusts quickly. Monetary disinflation leads to reduced real balances, higher interest rates, and a lower nominal exchange rate. In the short-run this causes a real appreciation and a decline in domestic manufacturing output. Perhaps surprisingly, an increase in world oil prices can create similar effects even for a country which is a net exporter of oil. Although the direct effect of an oil price increase for such a country is an increase in the demand for the domestic manufacturing good, that effect may be swamped by a real appreciation created by the increased demand for the home currency. This corresponds rather closely to the recent experiences of several oil and gas exporting countries, and is commonly referred to as the "Dutch-Disease". In our analysis, however, this is only a transitional phenomenon. Domestic oil discoveries, though necessarily finite in nature, generate permanent income effects in demand which last beyond the productive life of the new oil reserve. Initially, current income is above permanent income, leading to an improvement in the trade account; this is eventually reversed when permanent income exceeds current income. A wide variety of output response patterns are possible.