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264CHAPTER 9. THE NEW INTERNATIONAL MACROECONOMICSwelfare effects of policy interventions whereas it does not make sensein real business cycle models since all real business cycle dynamics arePareto efficient.The genesis of this literature is the Obstfeld and Rogoff [113] Reduxmodel. This model makes several surprising predictions that arecontrary to Mundell—Fleming. The model is somewhat fragile, however,as we will see when we cover the pricing-to-market reÞnement by Bettsand Devereux [10].In this chapter, stars denote foreign country variables but lower caseletters do not automatically mean logarithms. Unless explicitly noted,variables are in levels. There is also a good deal of notation. For ease ofreference, Table 9.1 summarizes the notation for the Redux model andTable 9.2 lists the notation for the pricing-to-market model. The termshousehold, agent, consumer and individual are used interchangeably.The home currency unit is the ‘dollar’ and the foreign currency is the‘euro.’9.1 The Redux ModelWe are set in a deterministic environment and agents have perfectforesight. There are 2 countries, each populated by a continuum ofconsumer—producers. There is no physical capital. Each householdproduces a distinct and differentiated good using only its labor and theproduction of each household is completely specialized. Households arearranged on the unit interval, [0, 1] with a fraction n living in the homecountry and a fraction 1−n living in the foreign country. We will indexdomestic agents by z where 0