Propagation of nominal shocks in open economies

Empirical evidence documents substantial persistence in the adjustment process to nominal shocks. Existing open-economy models either have failed to generate interesting dynamics or have found that the mechanisms are quantitatively weak. We consider the propagation of nominal shocks in a fully specified stochastic intertemporal open-economy model with incomplete capital markets and staggered nominal wage contracts. It is shown that persistence depends on wage-price interdependences (spiral), which in turn in a general equilibrium setting depend on structural parameters characterizing both the demand and the supply side of markets. Parameter choices strengthening wage-price interdependences thus strengthen persistence as is demonstrated analytically and illustrated numerically. A further product of the paper is that it develops a method by which to solve explicitly for a stochastic intertemporal version of the,new open-economy macroeconomics' model in which the expenditure switching effect is effective.