On Macroeconomic Implications of Price Setting in the Open Economy

Ever since its inception, the world system of floating exchanges rates has been characterized by large and persistent movements in currency values, both nominal and real, with apparently no tendency for purchasing power parity to assert itself either in the aggregate or on a product basis; in particular, there is growing evidence that the "law of one price" does not seem to hold even for tradables and that price-cost markups display large and persistent fluctuations. In the 1980's, these movements have been accompanied by worldwide high real interest rates and ample, long-lasting differentials, as well as persistent trade and current account imbalances on a grand scale for many countries. In addition, there has been widespread concern that expansionary policies in one large country-namely the United Statesmay have had adverse effects on others, European countries in particular (...).