A Test of Two Open-Economy Theories: Oil Price Rise and Italy

Abstract

The goal of the study is to empirically discriminate between two open-economy theories. The Keynesian theory holds that there is no, or only a very weak, homeostatic mechanism and, in the absence of government intervention, real income tends to remain below the level of full employment. In the monetary interpretation, the homeostatic mechanism is strong, and real income can be treated as though it were exogenous. This study examines the response of Italy to the sharp increase in oil prices in late 1973. The experience of Italy, as an oil-importing country, supports the monetarist view.