Essays in macroeconomics of an open economy (Q1202127)

The essays in this volume study the implications of the ``openness'' of an economy for stability, economic growth, resource allocation, adjustment in financial markets, and stabilization policy. The basic framework of the economy, described in Chapter 1, consists of a domestic sector and an international sector. The growth paths of the economy are characterized by a system of two differential equations governing the motions of the stocks of capital and natural resources. The stability of this economy is studied in Chapter 2, with emphasis placed on whether external shocks can be neutralized by means of only a suitable exchange adjustment and whether internal shocks can be absorbed as easily in an open economy as in a closed economy. Chapter 3 discusses the implications of the presence of under-utilized resources for resource allocation, income, consumption and investment in the two-sector economy. Consequences of an exchange rate variation and a trade balance change with income adjustment are examined for the cases where there is full comlementarity between capital and labor in both sectors and where there is full complementarity in the international sector and short-run substitutability in the domestic sector. Chapter 4 and 5 consider the time-optimizing behavior of households and firms, respectively. A feature of the household maximization problem is its explicit treatment of risk through the inclusion of the variance of expected income around its forecast as an argument in the utility function. Cross-sectional German data are provided to support the hypothesis that households are risk averse. Risk aversion in turn helps explain the adjustment of consumption to current income. In Chapter 5, in addition to the role of risk aversion in investment, the differences in investment behavior among the domestic sector, the international sector and the foreign sector are addressed. Chapter 6 is devoted to the labor market. Particular attention is given to wage determination in the domestic and the foreign sectors and to the differences between the short-run and the long-run behavior of wages. In Chapter 7, the effects of monetary policy are discussed, with emphasis placed on the subsitutability among various forms of wealth and its implications for the Barro thesis. Chapter 8 considers the differential effects of public debt creation and domestic and foreign investment on economic growth. An interesting result is that while government expenditures contribute to the efficiency of productive resources in the aggregate production function, it is pure accident that public debt bears any direct connection to national product. In particular, it is shown that when the interest rate is higher than the growth rate of the economy, public deficit reduces the permanent path of consumption. Although the motions of the economy are characterized in this volume by a set of differential equations, and the consumption and investment functions are derived from intertemporal optimization problems, the approach used throughout the volume is heuristic, thus is accessible to readers with an average technical background. The author has also made an attempt to compare predictions generated from the theory with empirical evidence, although the evidence provided is primarily anecdotal.