12. Foreign Sector Effects
The two key exogenous foreign sector variables in the model are the real value of exports EX and the price index for imports PIM. Imports IM and the price of exports PEX are endogenous. We have seen the effects of changing PIM in Experiments 7.1, 7.2, and 8.6. We have seen the effects of changing EX in Experiments 8.4 and 8.5.

It is not always sensible to take EX and/or PIM to be exogenous when experiments are being run, and we have so far ignored this problem. Without building a multicountry model, it is not really possible to endogenize EX and PIM, but a few partial steps in this direction can be taken. Say that you are increasing interest rates and you feel that this will lead to an appreciation of the dollar. If the dollar appreciates, PIM should go down (imports will be cheaper in dollars) and EX should go down (U.S. exports are now more expensive in foreign currencies). There are, of course, lags in the effects of exchange rate changes on PIM and EX, and these lags can be fairly long.

You can take foreign sector effects into account in the model if you are willing to specify ahead of time how PIM and EX are affected by whatever change you are making. You can enter your changes to PIM and EX along with your other changes and then solve the model. In the example of an interest rate increase, you will have to specify 1) how the interest rate increase affects the value of the dollar, 2) how the change in the value of the dollar translates into a change in PIM, and 3) how the change in the value of the dollar translates into a change in the U.S. price of exports in foreign currencies and how this in turn affects EX.

There is obviously some work involved in doing this, but it is necessary to do this short of constructing a complete multicountry model. Fortunately, there are only two key variables that you need worry about, PIM and EX, and so the adjustments are not too burdensome. Also, many of the changes that one makes when running experiments are likely to have only minor effects on PIM and EX, and so in many cases ignoring these effects is not likely to be very serious.