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Small Open Economy Model with Domestic Resource Shocks: Monetary Union vs. Floating Exchange Rate

Shimotsu, Tor (2002) Small Open Economy Model with Domestic Resource Shocks: Monetary Union vs. Floating Exchange Rate. Working Paper. University of Essex, Department of Economics, Economics Discussion Papers, Colchester.

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Abstract

This paper developes a small open economy model in which domestic resource shocks play a vital role in driving the dynamics of the major macroeconomic aggregates. Households rent capital and labour to firms and have access to an international bond market. The model is calibrated to recent Icelandic data and simulated under two alternative exchange rate regimes: floating rates, and monetary union membership. It is found that by entering a larger currency area, the volatility of the real exchange rate, real wages and consumption are sharply reduced, but output and employment are seen to be more volatile. Smoother consumption renders monetary union marginally Pareto superior to floating. Under monetary union and low inflation, slight nominal wage reductions may be required at times to absorb adverse resource shocks.

Item Type: Monograph (Working Paper)
Uncontrolled Keywords: domestic resource shocks, exchange rate regime, stabilization, welfare costs
Subjects: H Social Sciences > HB Economic Theory
Divisions: Faculty of Social Sciences > Economics, Department of
Depositing User: Users 161 not found.
Date Deposited: 28 Aug 2014 14:58
Last Modified: 28 Aug 2014 14:58
URI: http://repository.essex.ac.uk/id/eprint/8841

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