The Wage-Price Mechanism and the Long-Run Effects of Fiscal and Monetary Policies under Alternative Exchange Rate Regimes

Non‐traded Goods and the Long‐run Effects of Macroeconomic Policy Under Alternative Exchange Rate Regimes

“…The real equilibrium of the economy is affected by changes in the steady state rates of inflation and exchange rate depreciation, because they determine the real rate of return on money, but unless fiscal changes are accompanied by changes in the rate of monetary growth such changes cannot occur in the steady state. This is quite different from the result obtained by both Mundell (1963) and McKinnon (1976) that fiscal policy is less effective under floating rates than under fixed rates, but the same as found by Riley (1980). Mundell and McKinnon both assume some element of wage or price rigidity, so that the levels of the money stock and the exchange rate affect the equilibrium of the system.…”

“…Thus the effects of fiscal policies under fixed exchange rates are less clear cut in this model than in the one-good model analysed in Riley (1980), although there are certain similarities. In the one-good model, "pure" fiscal expansion is likely to lead to an improvement in the terms of trade, and thie will tend to permit a higher level of domestic output consistently with maintaining labour market equilibrium.…”

“…This unsatisfactory feature of the model is present also in the models analysed by Kingston andTurnovsky (1977, 1978), Riley (1980), and in other small country models. A true steady state solution requires the imposition of an extra constraint enforcing constancy of g and b.…”

“…The assumption of infinitely elastic demand for the country's good is crucial to McKinnon's result, as also is his assumption of fixed nominal wages. Exchange rate changes are necessary to produce output changes in his model but these are effectively ruled out if, as he assumes, interest rates arc fixed a t world levcls and thux, in the absence of shifts in liquidity preference, a fixed money stock implies a fixed nominal value of output.1 I n a recent paper- Riley (1980)-I have examined a model which relaxes these assumptions. Allowing a less than infinite elasticity of demand for the country's good +Manuscript received 6.4.81 ; final version received 15.7.82. tTho views oxpressed in this papor are those of the author, and not necessarily of the Treasury.…”

The Terms of Trade, Labour Supply and the Current Account

“…However the fact that changes in the terms of trade in final goods can have effects on output even when the labour market clears seems to have received little attention in the macroeconomic literature. Authors incorporating a model of the labour market similar in spirit to the one presented here include Branson and Rotemberg (1980), Buiter (1979), Riley (1982) andSachs (1980) although both Branson and Rotemberg, and Sachs are primarily interested in examining the implications of nominal or real wage rigidity, and none of them consider the implications for the behaviour of the current account. The closest antecedent of this paper is Salop (1974) who notes that with flexible wages and a fixed money supply a devaluation worsens the terms of trade, reduces employment and output, but improves the trade balance.…”