In Chapters 2 to 4, it was demonstrated that when the firm is rationed in the credit market, expansionary monetary policy leads to higher employment, whereas an expansionary fiscal policy reduces it. In this appendix, the differential effects of monetary and fiscal policies on employment are highlighted once again. Here, the interest rate is flexible. Section A.1 reviews the basic model; section A.2 discusses the comparative static results.

The model

The small, open economy produces a traded-composite good by employing domestic labor and previously produced goods. The domestic economic agents are the household, the firm, the treasury, and the central bank. The goods are labor, produced goods, domestic money, domestic bonds, and foreign money. There is no capital mobility.

The behavior of domestic economic agents is discussed below.

The treasury's purchases of goods are financed by issuing domestic assets (money and bonds). The central bank holds sufficient foreign currency reserves to maintain the exchange rate e. The households are rationed only in the labor market. The firms are not rationed in any market.

The domestic nominal wage w and the foreign nominal price of goods p* are rigid in the short run. However, the domestic nominal bond price q is flexible in the short run. Purchasing-power parity and a rigid world price of goods, normalized to one, imply that the exchange rate e is the domestic nominal price of goods.