The Balassa-Samuelson model, which explains real exchange rate movements in terms of sectoral productivities, rests on two components. First, the model implies that the relative price of non-traded goods in each country should reflect the relative productivity of labour in the traded and...

A new theory of price determination suggests that if primary surpluses are independent of the level of debt, the price level has to ‘jump’ to assure fiscal solvency. In this regime (which we call fiscal dominant), monetary policy has to work through seignorage to control the price level. If,...

It is commonly asserted that monetary and fiscal policy may have to be coordinated if they are to provide a nominal anchor and avoid the pathological outcomes of sunspots or explosive price paths. In this paper, we study a model in which government bonds are an imperfect substitute for money in...

Woodford (2003) describes a popular class of neo-Wicksellian models in which monetary policy is characterized by an interest-rate rule, and the money market and financial institutions are typically not even modelled. Critics contend that these models are incomplete and unsuitable for...

The Great Recession, and the fiscal response to it, has revived interest in the size of fiscal multipliers. Standard business cycle models have difficulties generating multipliers greater than one. And they also cannot produce any significant state-dependence in the size of the multipliers over...

We use a new theory of price determination – developed by Woodford, Simms and others – to characterize central bank independence and price stability. If fiscal policy guarantees that the price level is determined independently of government’s present value budget constraint, we can say...

While overall inflation has fallen dramatically in countries like Italy and Spain, inflation in the home good sector remains stubbornly higher than inflation in the traded good sector. If nominal exchange rates are fixed, these real appreciations imply an inflation differential with countries...

Models that assume bonds denominated in different currencies are perfect substitutes can not explain certain empirical puzzles: the exchange rate volatility puzzle is that these models can not explain the observed volatility in real and nominal exchange rates; the Backus-Smith puzzle is that...

What are the costs and benefits of the dollar's status as the key currency in the international monetary system? Here, we present a calibrated two country model in which all exports are invoiced in the key currency, and government bonds denominated in the key currency are held internationally to...

What determines the cyclical behavior of aggregate inflation and regional inflation differentials? The answer has strong implications for monetary policy and in Europe for the Stability and Growth Pact. In the United States, inflation rates move pro-cyclically, and across the Euro Area,...