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4 - Recent developments in the macroeconomic stabilisation literature: is price stability a good stabilisation strategy?
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- By Matthew B. Canzoneri, Professor of Economics at Georgetown University since 1985, Robert E. Cumby, Professor of Economics in the School of Foreign Service of Georgetown University., Behzad T. Diba, Professor of Economics at Georgetown University
- Edited by Sumru Altug, Koç University, Istanbul, Jagjit S. Chadha, Charles Nolan, University of Durham
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- Book:
- Dynamic Macroeconomic Analysis
- Published online:
- 13 September 2019
- Print publication:
- 20 November 2003, pp 212-242
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Summary
INTRODUCTION
A New Neo-classical Synthesis (NNS) is merging three traditions that have dominated macroeconomic modelling for the last thirty years. In the 1970s, Sargent andWallace (1975) and others added rational expectations to the IS-LM models that were then being used to evaluate monetary policy; somewhat later, Calvo (1983) and Taylor (1980) introduced richer dynamic specifications for the nominal rigidities that were assumed in some of those models. In the 1980s, Kydland and Prescott (1982) and others introduced the Real Business Cycle (RBC) model, which sought to explain business cycle regularities in a framework with maximising agents, perfect competition, and complete wage/price flexibility.
The NNS reintroduces nominal rigidities and the demand determination of employment and output. Monopolistically competitive wageand price-setters replace the RBC model's perfectly competitive wage- and price-takers; monopoly markups provide the rationale for suppliers to expand in response to an increase in demand; and the Dixit and Stiglitz (1977) framework – when combined with complete sharing of consumption risks – allows the high degree of aggregation that has been a hallmark of macroeconomic modelling.
In this chapter, we present a simple model that can be used to illustrate elements of the NNS and recent developments in the macroeconomic stabilisation literature. We do not attempt to survey this rapidly growing literature. Instead, we focus on a set of papers that are key to a question that is currently being hotly debated: is price stability a good strategy for macroeconomic stabilisation? If so, some of the generally accepted tradeoffs in modern central banking would seem to evaporate. For example, inflation (or price-level) targeting need not be seen as a choice that excludes Keynesian stabilisation, and it would be unnecessary to give price stability such primacy in the statutes of the new central bank in Europe.
In section 2, we present our model and discuss some fundamental characteristics of the NNS. Our model is simpler than that which appears in much of the literature because we have replaced the dynamic Calvo and Taylor specifications of nominal rigidity with the assumption that some wages and/or prices are set one period in advance. This allows us to derive closed form equilibrium solutions for a class of utility functions and assumptions about the distribution of macroeconomic shocks.
7 - Fiscal federalism and optimum currency areas: evidence for Europe from the United States
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- By Xavier Sala-i-Martín, Yale University, Jeffrey Sachs, Behzad T. Diba, Georgetown University, Alberto Giovannini, Columbia University and CEPR
- Edited by Matthew B. Canzoneri, Georgetown University, Washington DC, Vittorio Grilli, Birkbeck College, University of London, Paul R. Masson, International Monetary Fund Institute, Washington DC
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- Book:
- Establishing a Central Bank
- Published online:
- 05 March 2012
- Print publication:
- 30 July 1992, pp 195-227
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Summary
Introduction
Some background
The issue of the appropriate exchange rate (ER) system for Europe is now hotly debated. Yet the question of whether Europe should have a single currency is not new. It goes back to the very first debates surrounding European economic integration of the late 1940s and the 1950s. From the very beginning people have asked what, in our opinion, is a central question: why do ER problems seem not to exist within some subsets of countries or within a country with a diversity of regions (as, for instance, the United States), while they do exist in the world as a whole? Put differently, why has the ‘irrevocably fixed’ ER system within the US functioned well, while the Gold Standard and the Bretton Woods systems collapsed? Economists have phrased this question in the following way: what constitutes an optimum (or at least reasonably good) currency area?
Different schools have answered this question differently. Classical economists argued that the key variable to exchange rate regimes is transactions costs. Because these transactions costs represent social losses, they should be minimized and the way to do it is to have a single worldwide currency. Thus the entire world is an optimum currency area. J. S. Mill puts it in a very illustrative way:
‘…So much of barbarism, however, still remains in the transactions of most civilized nations, that almost all independent countries choose to assert their nationality by having, to their own inconvenience and that of their neighbors, a peculiar currency of their own.’