Modeling the effects of foreign prices on domestic price determination: some econometric evidence and implications for theoretical analysis

Abstract

By letting prices be determined entirely by the requirements of macroeconomic equilibrium, flexible-price models bypass the issues of how prices and wages are set in the short run and whether there is any direct linkage between domestic price and wage formation and the levels of prices and wages internationally. This paper deals with such direct linkages between international and domestic prices and wages. Aside from a few papers, there appears to have been little effort made to account for international influences on domestic price formation at the theoretical macroeconomic level. The authors first offer a brief theoretical discussion of international price relationships. An analysis of empirical evidence as contained in several large national econometric models is then carried out. 

JEL: E31, E24, E37