Welfare and Macroeconomic Interdependence

Abstract

We develop a baseline model of monetary and fiscal transmission in interdependent economies. The welfare effects of expansionary policies are related to monopolistic supply in production and monopoly power of a country in trade. An unanticipated exchange rate depreciation can be beggar-thyself rather than beggar-thy-neighbor, as gains in domestic output are offset by deteriorating terms of trade. Smaller and more open economies are more prone to suffer from inflationary shocks. Larger economies benefit from moderate demand-led expansions, but may be worse off if policy-makers attempt to close the output gap. Fiscal shocks are generally beggar-thy-neighbor in the long run; in the short run they raise domestic demand at given terms of trade, thus reducing the welfare benefits from monetary expansions. Analytical tractability makes our model uniquely suitable as a starting point to approach the recent "new open-economy macroeconomic" literature.

Useful government spending, direct crowding-out and fiscal policy interdependence

“…The (per-capita) government real consumption index aggregate over government spending for the di¤erent varieties of goods, with the same elasticity of substitution 8 :…”

“…The introduction of overlapping generations in the model, that would break down Ricardian equivalence, is left for future work. 8 This assumption eliminates the so called "elasticity e¤ect of the spending mix" (see Dixon and Rankin 1994, p. 189 and the references therein cited): changing the share of government demand on total demand has no e¤ects on the (constant) elasticity of total (private plus public) demand. 9 Equations (13) and (14) are derived integrating demand for good z across all agents, and exploiting the fact that the law of one price and the PPP imply that p(z)=P = p ¤ (z)=P ¤ for any good z.…”

“…The latter property is present in similar models (e.g. Svennson 1987, Rankin 1990, Corsetti and Pesenti 1997), but an intuition for its causes has not been provided yet. Our analysis shows that home bias in government spending can be considered as the main determinant of "quasi-neutrality".…”

The valuation channel of external adjustment

“…This is the central mechanism for the results in Cole and Obstfeld (1991) and Corsetti and Pesenti (2001):…”

Labour Market Asymmetries in a Monetary Union

“…In the general case, individual decisions will depend on initial wealth, which implies that decisions will be path dependent, cf. Obstfeld and Rogoff (1995) and Corsetti and Pesenti (2001). This causes both substantial technical problems, and problems with multiplicity of equilibria.…”