New Open Economy Macroeconomics: Contrast with Earlier Models
This baseline NOEM model is different in several key ways from both the Mundell-Fleming model and the intertemporal approach to the current account that preceded it. Unlike the intertemporal approach to the current account (earlier multiperiod optimizing models of the open economy), the NOEM model includes nominal rigidities and market imperfections. These features allowtheNOEMmodel to look at the short-run effects of policy decisions, including any effects of monetary policy. Unlike theMundell- Fleming model, this NOEM model is a dynamic general equilibrium model: it has explicit microfoundations (all agents are given objective functions to determine their behavior) and it has intertemporal choice (agents are making choices taking into account future periods). These differences allow the models to look at the dynamic effects of policies or shocks (as opposed to solely comparative statics), in particular on the current account and budget deficits. In addition, theNOEMmodel can evaluate different policies based on explicit welfare criteria that are consistent with the structure of the model.
For example, unlike later versions of theMundell- Fleming model, in reaction to the home central bank loosening monetary policy this version of the NOEM model has no exchange rate overshooting, where the exchange rate moves by a greater amount immediately than itwill in the long run.This result is of interest to international economists because they would like to explain why exchange rates seem to movemore than can be explained by changes in other macroeconomic variables or inways contrary towhat their models would suggest. For the reasons described earlier, home consumption relative to foreign consumption will immediatelymove to its new level, as will the relative money supplies in the two countries, and therefore the exchange rate.
Moreover, in the Mundell-Fleming model, the unexpected easing of home-countrymonetary policy raises output in the home country and lowers it in the foreign country, as the depreciation of the exchange rate makes home goods cheaper for foreigners. The depreciation is therefore said to have a beggar-thyneighbor effect. In contrast, in the original version of the NOEM model, home and foreign households benefit equally fromthe easing of monetary policy in the home country. Both gain because households in each country have some monopoly power over their output and produce less individually than theywould if society as a whole would choose their output for them. Monetary policy increases the utility of all households because it causes the expansion of output, and because both home and foreign households are equally affected by the market distortion. The point, however, is not so much the differences in results extensions to the original model can restore some of the conclusions from earlier models but rather the ability to look at dynamics and welfare conclusions.