Chapter 13 Macroeconomic theory and policy: How the closed economy was opened

Abstract

This chapter discusses history of international transactions and relationships that were introduced into macroeconomic models and policy in the twenty-five years following the Second World War. Modern models of exchange-rate determination focus sharply on money and bond markets. The chapter discusses the Marshall–Lerner–Robinson that was developed to show how a change in the exchange rate affects the current-account balance. The Keynesian multiplier has been used to show how changes in domestic activity affect the balance of payments and to trace the propagation of business fluctuations. The chapter focuses on the aims and instruments of economic policy. It discusses fixed and flexible exchange rates that are dealt mainly with the best technique for altering rates promptly. The ways in which exchange-rate changes can influence wages and prices, nominal rates of return on financial instruments, or the demand for real balances are also discussed in the chapter. Finally, it reviews that the actors within any economic model base their own decisions on experience. The ways in which households, firms, and governments respond to information are conditioned by earlier successes and mistakes. They may be maximizing something or other, but their strategies are almost always based on imperfect information and imperfect methods for collecting and assessing it. The institutional framework within which they operate is itself a product of experience. Economists design their own models to fit certain sets of facts, frequently subsets of “stylized facts” distilled from recollection and observation by methods that lead to build models that fit the recent facts most closely.