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Credit, wages and prices in a small open economy: Portugal
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The three essays that follow analyze important aspects of the macroeconomics of a semi -industrialized, small open economy.
The first chapter is about credit rationing and macroeconomic equilibrium. In the first part firm behavior is analyzed within the framework of an imperfect financial market. In particular, it is assumed that credit supply is positively sloped, i.e., that the interest rate grows with the amount of indebtedness. The conclusion is that in the short run credit market conditions affect the firm's demand for variable factors of production - thus short run supply - and the demand for investment. If there are no increasing costs associated with investment,
then only demand for capital goods is affected, unless optimal investment is zero. Under this assumption of no increasing costs, the standard macroeconomic results hold. In the short run, monetary (credit) policy affects primarily domestic spending, via investment demand. The- counterpart is the balance of payments. In the long run real variables are independent of monetary policy.
The second essay is an empirical study of price determination and short run monetary equilibrium for the Portuguese economy, The first part develops reduced form price equations for traded and non -traded
goods. The empirical results lend strong support to the "small country" hypothesis. Traded goods prices follow international prices. Nontraded goods prices are roughly proportional to domestic labor costs.
Available data does not allow firm conclusions about the role of domestic demand in (non -traded goods) price formation. The second part of Chapter II tests the "monetary approach to the balance of payments".
The empirical results strongly support the hypothesis that the excess demand for high powered money is cleared via the capital account of the balance of payments.
The third essay deals with domestic inflation and supply of traded goods within the framework of the "Scandinavian model". In the first part a few alternative hypotheses for wage formation are compared. These are constant income shares in value added, indexing, and the "international wage" hypothesis. The latter corresponds to "small, open" hypothesis applied to the labor market. A simple empirical test of this hypothesis is performed for a few European countries. The results for Portugal, Italy and Finland support the hypothesis. In the cases of Spain and Ireland the hypothesis is not rejected, but the test has very little power. The second part of the third chapter analyzes issues like aggregate demand and unemployment within the framework of
the first part. It shows how the international wage hypothesis can be linked to an otherwise standard Phillips curve. In the short run, prices and/or wages obey the Phillips curve; in the long run, when the Phillips curve is vertical, the Scandinavian model holds and domestic wages are proportional to the international wage.