Real exchange rate and employment performance in an open economy

The usual neoclassical model of labor supply and employment determination has been based in closed economy models. This paper studies the effect of introducing open economy features on the determinants of equilibrium employment. It derives the long run employment level as a function of the real wage, real interest rate and real exchange rate from a standard open economy optimizing representative agent model. The paper tests the steady state solution of the model using US and UK data and, in order to avoid the Lucas' critique, it tests for the superexogeneity of the interest rate and exchange rate. The evidence shows a significant impact of the real exchange rate, real interest rate, and real wage only for the US, where it is also robust to the Lucas' critique. (C) 2005 University of Venice. Published by Elsevier Ltd. All rights reserved.