SUPPLY SHOCKS AND STABILIZATION POLICY UNDER FLEXIBLE EXCHANGE RATE REGIME

This dissertation aims to construct a dynamic model of an open economy that is heavily dependent upon the rest of the world for its material supply. I then investigate the effectiveness of, and the limitations to the conventional demand management tools in coping with disturbances both on the demand and the supply sides. The empirical analysis of the dissertation is focused on the Oil Crisis Recession in Japan. In Chapter II, I start with a short run model of the import cost shock. Its three essential effects--output decline, domestic price rise, and the current account deficit--are demonstrated. Chapters III and IV are devoted to the microscopic foundation of the supply shock analysis. Chapter III examines the institutional development of the postwar Japanese economy and its implications on the behaviors of the firm sector. Chapter IV develops a model of the monopolistic firm under the employment constraint. We derive a set of behavioral equations for the firm that resemble the mark-up pricing policy in the short run. We also obtain the firm's employment policy as one of the major elements of the long run dynamics of the economy. In Chapter V, we present the dynamic model. It exhibits two drastically different modes of the dynamics of the economy. In the neighborhood of the long run equilibrium, the dynamic motion is stable and it is driven by the relative price adjustments. Outside this stable region, interactive forces among the aggregates such as the multiplier process, and the asset accumulation process determine the nature of the dynamics. In this Keynesian regime, the economy is likely to present cyclical fluctuations in output, employment, and the exchange rate. After a historical inquiry of the Oil Crisis Recession in Chapter VI, I estimate an econometric model of the Japanese economy that is based upon the model in Chapter V. Not only does the econometric model demonstrate its applicability to the Japanese experience, it also confirms the crucial findings in the preceding theoretical investigation of import cost shocks (Chapter VII).