The dynamics of open economy models embodying the assumption of perfect foresight have attracted a great deal of attention in the literature over recent years. A familiar conclusion to emerge from earlier analyses of dynamic monetary models under perfect foresight is that these models typically exhibit saddlepoint instability (see, for example, Burmeister and Dobell [1970], Nagatani [1970], Black [1974]). One approach around this instability problem, introduced by Sargent and Wallace [1973], is to assume that following any exogenous shock the system would jump to a stable path which converges to the new equilibrium. This procedure has been adopted by a number of authors (for example, Dornbusch [1976], Gray and Turnovsky [1979], Dornbusch and Fischer [1980], and Burmeister, Flood and Turnovsky [1981]).2 An implication of the jump is that at the point in time in which it occurs the assumption of perfect myopic foresight does not hold. However, as Gray and Turnovsky [1979] argued, this can be justified on the grounds that when a given shock is completely unanticipated it seems excessively stringent to require that expectations be perfectly accurate at the instant that the shock impinges on the system. Similar justification can be made in the case of pre-announced or anticipated policy changes as considered by Wilson [1979], Boyer and Hodrick [1982], as well as Gray and Turnovsky [1979]. In this case, the initial jump occurs at the time of announcement and the system remains on a continuous new equilibrium path at the time of policy implementation. Further, empirical evidence provides some support for the assumption that a system embodying the rational expectations hypothesis (or its deterministic analogue, perfect myopic foresight) will not arch away from the new equilibrium along a divergent path (see Flood and Garber [1980]). This paper deals with an economy operating under a flexible exchange rate and with perfect myopic foresight in expectations of the inflation rate and the rate of