The paper gives a brief overview of the current state of exchange rate modeling. First section discusses the status of Mundall-Fleming-Dornbusch model. This model demonstrated undeniable time-tested appeal. However, it needed update as regards to microfundations which was made possible in Redux model. Redux model made a breakthrough as to allow for an explicit welfare analysis as far as policy is concerned. The literature covering new open economy macroeconomics is expanding since 1990s, provoked by seminal paper by Obstfeld and Rogofff, in which authors give their perspective of economy reactions to monetary shocks. Redux model assumes real impact of monetary shocks on consumption, output level and exchange rates, allowing for purchasing power parity and low of one price to hold. Welfare is equally increased both domestically and internationally after positive monetary shock. Consumption increases leading economy towards its optimum, reachable only at perfectly competitive markets. Economy is fully adapted to shock only after one time period. However, monetary shocks could have longer real effects due to accumulated welfare. Money is not neutral in this modei, not even in the long run. The welfare results of the new open economy macroeconomics literature are highly sensitive to the precise denomination of price stickiness and the specification of preferences. For this reason the literature is of only limited interest in policy circles. This new developments in models will encourage further research in the new open economy macroeconomics.
How Well Can the New Open Economy Macroeconomics Explain the Exchange Rate and Current Account?