International Finance in General Equilibrium
Our purpose in this paper is to unify international trade and ﬁnance in a single general equilibrium model. Our model is rich enough to include multiple commodities (including traded and nontraded goods), heterogeneous consumers in each country, multiple time periods, multiple credit markets, and multiple currencies. Yet our model is simple enough to be eﬀectively computable. We explicitly calculate the ﬁnancial and real eﬀects of changes in tariﬀs, productivity, and preferences, as well as the eﬀects of monetary and ﬁscal policy. We maintain agent optimization, rational expectations, and market clearing (i.e., perfect competition with flexible prices) throughout. But because of the important role money plays, and because of the heterogeneity of markets and agents, we ﬁnd that ﬁscal and monetary policy both have real eﬀects. The eﬀects of policy on real income, long-term interest rates, and exchange rates are qualitatively identical to those suggested in Mundell-Fleming (without the small country hypothesis), although our equilibrating mechanisms are diﬀerent. However, because the Mundell-Fleming model ignores expectations and relative price changes, our model predicts diﬀerent eﬀects on the flow of capital, the balance of trade, and real exchange rates in some circumstances.
Geanakoplos, John and Tsomocos, Dimitrios P., "International Finance in General Equilibrium" (2001). Cowles Foundation Discussion Papers. 1572.