KOHL, REAGAN, AND OPEN-ECONOMY MACROECONOMICS - REVISITING RULES FOR FISCAL AND MONETARY-POLICY

This paper models three alternative policy strategies for an open econ omy and evaluates their performance. In the first regime national mone tary policies are used to achieve domestic price stability, without su pporting fiscal policy and without concern for external balance. The s econd regime adds to this fiscal policy assigned to controlling the ex ternal balance. In the third regime, monetary policy, via the exchange rate, is assigned to external balance and fiscal policy is used to co ntrol inflation. We show that the first regime might be unstable, or, if stable, that it might give rise to large swings in foreign wealth h oldings and in real exchange rates. These problems can be avoided in e ither of the other two regimes, but the fluctuations in the real inter est rate and the real exchange rate in response to shocks are larger i n the second regime than in the third.