A simple parable of price stickiness and international externalities

Olivier Blanchard and Nobuhiro Kiyotaki published a famous "Keynesian" paper in 1987 and it remains a well-cited piece in macroeconomics.  One central result is that prices and wages can get stuck too high, above market-clearing.  Market participants who produce more and lower prices and wages confer a strong large and positive externality on other individuals (or regions) in the market.  Of course in the absence of such adjustments, activist monetary policy is recommended, but the point about externalities remains.

Yet often, today, we are told that the individuals (or regions) which produce (i.e., export) more are imposing negative externalities on other individuals or regions.

Of course the Blanchard and Kiyotaki model had its limitations.  It did not, for instance, incorporate open economy considerations.  It could be that the star producers impose an unfavorably high exchange rate on the broader region and hurt the ability of the broader region to export to the larger world economy.

When the open economy considerations are relatively strong, that coincides with…the conditions under which a coordinated fiscal policy will prove counterproductive, for reasons shown by the Mundell-Fleming model.  In other words, if you think the strong Eurozone countries are hurting the Eurozone weakies, you also should be skeptical about coordinated European fiscal policy.  This paper surveys some key issues.

In many open economy versions of the B-K model, or variants, looser monetary policy simply exports the problems of the region to other parts of the world.  So why advocate such policies, especially if you are an outsider?  Maybe the EU determines its own economic destiny (fine by me) but then we're back to German production and prosperity helping Spain rather than hurting it, for the reasons given by B-K.

In this well-regarded model, the international spillover effects from the monetary expansion can be either positive or negative.  But it takes work to get those effects into the positive category.

Here is a survey of some literature which extends the sticky price model to open economy and policy coordination settings.

It is commonly suggested that German exports damage (or help) Spain without considering the broader implications of that proposition.

Overall, the results may depend on whether wage rigidity is real or nominal in each currency, the degree of capital mobility, the currency of invoicing in which sticky prices are set, and how much market participants look forward and consider stocks in addition to flows.  This paper surveys some issues.  There are many permutations, to the point where they are perhaps no longer very useful.

I wish to emphasize the broader point that not all combinations of views here are mutually consistent.


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