AGGREGATE SUPPLY AND DEMAND, THE REAL EXCHANGE RATE AND OIL PRICE DENOMINATION
Bank of Greece and University of Athens
In an aggregate supply, aggregate demand model of an open economy with imperfect competition in labour and product markets, the effectiveness of monetary and fiscal policies depends on the degree of wage indexation, the exchange rate regime and the currency denomination of the international prices of raw materials, such as oil. In a two country world with a floating exchange rate, real consumer wage rigidity and the prices of imported raw materials fixed in the currency of Country 2, monetary policy is effective only in Country 2, but fiscal policy is relatively more effective in Country 1. These results may explain certain characteristics and have certain implications for economic policy in the US and the Eurozone.
Keywords: Open economy macroeconomics, real exchange rate, oil price denomination
JEL classification: F41,Q43
I wish to thank participants in research seminars in the Economic Research Department, Bank of Greece and in the Department of Economics, University of Athens for their useful comments. Particularly I wish to thank Vassilis Droucopoulos and George Krimpas for insightful suggestions and a useful discussion on the subject.
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