DP168 Wage Rigidity and Capital Mobility in an Optimizing Model of a Small Open Economy

Author(s): Theo C N J van de Klundert, Frederick van der Ploeg
Publication Date: March 1987
Keyword(s): Capital Mobility, Fiscal Policy, Monetary Policy, Open Economy, Purchasing Power Parity, Wage Rigidity
JEL(s): 023, 311, 321, 431
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=168

This paper formulates an optimizing model of a small open economywith a representative (immortal) household, a firm and agovernment. The asset menu consists of domestic currency,non-traded bonds and traded bonds. There is a risk-premium ontraded bonds, which leads to deviations from perfect capitalmobility and UIP. Taxes are lump-sum, so that finance by bonds andby taxation are equivalent. The model allows for current-accountand wealth dynamics. There are six versions of the model dependingon whether one assumes purchasing power parity or imperfectsubstitution between home and foreign goods and on whether there islabour market equilibrium, nominal wage rigidity or real wagerigidity. For each of these variants, the steady-state effects of afiscal contraction, monetary disinflation, a worsening of thesupply side, an increase in the world interest rate, and a resourcediscovery are discussed. The transient effects of these policiesfor some of these versions are analysed with the aid of a "multipleshooting" algorithm.