Academic journal article Atlantic Economic Journal

Extension of Romer's IS-MP-IA Model to Small Open Economies

Academic journal article Atlantic Economic Journal

Extension of Romer's IS-MP-IA Model to Small Open Economies

Article excerpt

Recently, Romer [JEP, 2000] proposed the IS-MP-IA model to focus on the inflation-output relationship and the federal funds rate as a monetary policy instrument. This note attempts to extend Romer's model to examine the relationship between currency depreciation and real output. Many studies, such as Arize [AE, 1990], Morley [RES, 1992], Upadhyaya [EL, 1999], Bahmani-Oskooee [JPKE, 2002; EI, 2003], Calvo and Mishkin [2003], and others, indicated that an emerging market economy needs to choose an appropriate exchange rate regime and that the impact of currency depreciation on output may be ambiguous and need further theoretical investigation.

In the extended model, the IS function can be expressed as Y = C(Y - T) + I(r) + G + NX[e(P/[P.sup.f])], where Y, C, T, I, r, G, NX, e, P, [P.sup.f] stand for real output, consumption spending, government taxes, investment spending, the real interest rate, government spending, net exports, the nominal exchange rate, the domestic price level, and the foreign price level. The monetary policy (MP) function can be written as r = f([pi], Y, e), where [pi] is the inflation rate. The inflation adjustment (IA) function is given by [pi] = [[pi].sup.*] + [alpha](Y - [Y.sup.*]) + [beta](e), where [[pi].sup.*] and [Y.sup.*] represent the expected inflation rate and potential output.

Let [C.sub.Y] > 0, [I.sub.r] < 0, N[X.sub.e] > 0, [r. …

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