The Dynamics of a Small Open Economy under Alternative Exchange Rate Regimes Patterns in Neighboring Areas

This paper extends the literature on open economy macroeconomics by studying the endogenous dynamics of a structural model under various exchange rate regimes. We assume that agents have near-rational expectations concerning the formation of future nominal wages so that there is no money neutrality. The paper characterizes the region of parameters that yield unique stable equilibria, and shows how different exchange rate policies can make stability easier or harder. We also study the possibility of cycles. Nominal inertia in the form of near-rationality is not sufficient to generate cycles and hence overshooting.