DP1231 Nominal Rigidity and Monetary Uncertainty in a Small Open Economy

Author(s): Neil Rankin
Publication Date: August 1995
Keyword(s): Exchange Rate, Monetary Uncertainty, Nominal Rigidity, Risk Premium
JEL(s): E44, F41
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1231

A dynamic stochastic model of a small open monetary economy with infinitely-lived optimizing households is constructed. There are temporary nominal rigidities in the labour market, while in goods and asset markets prices are flexible. Optimizing behaviour in the foreign country is also modelled. The home country is small relative to the foreign country, so the latter is effectively a closed economy. We show that whereas in the closed economy an anticipated increase in monetary variability has no effect on current macroeconomic variables, in the small open economy it weakens the current exchange rate and expands current output.