Money, strongGrowthstrong and External Balance in a Small Open Economy.pdf

ATHENS UNIVERSITY OF ECONOMICS AND BUSINESS DEPARTMENT OF ECONOMICS WORKING PAPER SERIES 16-2012 Money, Growth and External Balance in a Small Open Economy George Alogoskoufis 76 Patission Str., Athens 104 34, Greece Tel. (++30) 210-8203911 - Fax: (++30) 210-8203301 www.econ.aueb.gr Money, Growth and External Balance in a Small Open Economy George Alogoskoufis Athens University of Economics and Business* September 2012 Abstract This paper puts forward an intertemporal model of a small open economy to analyze the effects of money, government debt and real shocks on growth, inflation and external balance. The model is an endogenous growth, overlapping generations model, with money in the utility function, convex adjustment costs for investment, and perfect substitutability between domestic and foreign bonds. It is shown that the growth rate depends only on the world real interest rate, the productivity of domestic capital, the adjustment cost parameter for investment and the depreciation rate. It does not depend on money, budgetary policies or the preferences of domestic consumers. Consumption of goods and services and external balance, in addition to the world real interest rate and the domestic productivity of capital, depend on money, budgetary policies and the preferences of domestic consumers. The model is used to analyze the full effects of real and monetary shocks. Monetary growth is not superneutral in this model, as it affects domestic consumption and the net foreign position of the economy. Keywords: money, endogenous growth, external balance, current account, interest rates, government debt, monetary policy, fiscal policy JEL Classification