Money and the Open Economy Business Cycle: A Flexible Price Model

   (568 K)

   (316 K)

This paper develops an open-economy model of the business cycle. The

nominal prices in the model are flexible and monetary nonneutrality is

developed using information confusion about the sources of disturbances to

demand coupled with differential persistence of demand shocks. Firms use

inventories to smooth their production, and consumers follow a stochastic

permanent income expenditure function. The major implication of the model

is that unperceived monetary disturbances improve the terms of trade and

increase real output in contrast to sticky price models in which the terms

of trade deteriorates. This implication of the model is examined

empirically.

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