Chapter 16 The specification and influence of goods and factor markets in open-economy macroeconomic models

The art of macroeconomic model-building involves making strategic choices among a wide range of alternatives. Theoretical models range from the equation of exchange of the simple quantity theory to vast dynamic models involving many sectors and many agents and which defy analytical solutions. The chapter focuses on theoretical models and considers the implications for open-economy models of alternative assumptions that are made when specifying goods and factor markets. It presents two simple benchmark models: one that focuses completely on monetary factors at the expense of neglecting structural considerations entirely, and the other that focuses on structural factors but that fails to provide a complete model capable of determining the endogenous variables. The two benchmark models are combined under the assumption that real national output and income are constant. The chapter introduces the role of the labor market and discusses the possibility of unemployment. In turn this creates room for output movements as part of the adjustment process, either as a result of changes in unemployment or as a result of endogenous changes in the equilibrium level of output because of changes in equilibrium relative prices. Finally, the chapter discusses the inter-temporal models that focus on the long-run aspects of savings, investment, and international capital movements.