DP1231 Nominal Rigidity and Monetary Uncertainty in a Small Open Economy
|Publication Date:||August 1995|
|Keyword(s):||Exchange Rate, Monetary Uncertainty, Nominal Rigidity, Risk Premium|
|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.