Openness and the Cost of Relinquishing the Exchange Rate.

De Grauwe follows McKinnon in arguing that "for a very open economy the exchange rate is a particularly ineffective instrument." Since most countries are becoming more open this suggests that the exchange rate instrument is declining in importance. We identify a set of circumstances under which this argument is correct; our calibration model suggests however that in this case the argument is of little practical significance. Under an alternative set of circumstances however, openness not only enhances the output and employment effects of exchange rate changes, but does so significantly.