Monetary and Fiscal Policy in Open, Interdependent Economies with Fixed Exchange Rates
Analysis of open economies has been restricted in several important ways. One is the assumption, common also in much of the macro-economic analysis of a closed economy, that total output is fixed and invariant. A second restriction arises from treatment of the representative country as a small unit in a large market. All prices are set in competitive world markets, and exchange rates adjust to equate domestic and foreign prices. Three, asset portfolios are restricted to money and real capital, the latter is generally fixed or grows at a steady rate. Bonds and real capital are perfect substitutes, as in the Metzler model (1951) or Mundell's several extensions of that model (1968).