SFB 303 Discussion Paper No. A - 081

Author: Neumann, Manfred J. M., and Jürgen von Hagen
Title: An Aggregate Supply Function for the Open Economy with Flexible Exchange Rates
Abstract: In this paper we develop an aggregate supply function for an open economy with flexible exchange rates. Such a setting differs from the Lucas-world in two important ways: First, due to its openness the economy is exposed to additional nominal and real aggregate shocks, transmitted from world markets into the economy by international trade. Secondly, the observable, flexible exchange rate can be used by market participants as a common source of additional information. Similar to the interest rate on an economy-wide asset market, Barro (1980) and King (1983), the flexible exchange rate aggregates information and expectations across markets, hence provides a global signal in addition to the local price. Both aspects of an open economy with flexible exchange rates, the enlarged shock structure and the richer information structure, modify the effects of nominal and real aggregate shocks on output and the price level in important ways.
Creation-Date: October 1986
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