A flatter Phillips curve in open economies — where imports form a share of consumption and production costs — renders CPI-based inflation a lagging indicator of excess demand, increasing the risk of understating economic overheating. I develop a model that connects excess demand with forex market pressure, captured by an external output gap — defined as the deviation of output from the balance-of-payments consistent level. The external output gap serves as a leading indicator of overheating, where excess demand is masked by subdued CPI-based inflation (overheating on ice). The model introduces a composite output gap as a weighted average of domestic and external gaps. Crucially, it can be positive even when the domestic output gap is negative, leading to biased estimates from filtering methods. Incorporating the composite gap into business cycle analysis is essential to prevent excessively loose policy, while a focus on non-tradable or cost-based inflation is required to assess domestic inflationary pressures.

This article develops a model to examine the U.S. trade deficit, motivated by three facts: (i) a clockwise convergence dynamic between the trade balance and nominal exchange rate (1990Q4–2009Q1); (ii) the central role of valuation effects in external adjustment; and (iii) the macro-financial disruptions following the 2025 Trump tariffs. The framework combines a short-run trade balance schedule — capturing goods-market equilibrium and valuation effects — with a long-run schedule consistent with a stable NIIP and no persistent asset revaluations. Calibration suggests that the trade deficit reflects persistent under-investment relative to the Golden Rule benchmark. Tariff shocks trigger financial decoupling — rising inflation expectations and long-term borrowing costs — which reduce the expected return on U.S. assets, depress asset prices, and curb domestic absorption. These effects generate dollar depreciation and a smaller equilibrium trade deficit. The optimal unilateral tariff is 8.32 percent, and the optimal fiscal deficit share of GDP is 0.135 percent.

This article presents a simple macro model that qualitatively fits several dismal facts of Caribbean economies, including low growth and high public debt ratios, high unemployment, persistent fiscal dominance, repeated balance of payments crises, trend decrease in productivity growth, high rates of skilled migration, persistent excess bank reserves, and wide interest rate spreads in commercial banks. The motivation for this model extends beyond these observations. Another goal is to emphasise the importance of economic theory for prediction, empirical research, and policy analysis, and to stimulate theoretical research in the region. The model has three key components: (i) a bank-based aggregate demand, (ii) a balance of payments constraint, and (iii) a supply constraint exacerbated by skilled migration in the very long term. In equilibrium, the model derives six distinct economic regimes that can account for diverse country experiences. Overall, fiscal dominance is the key causal factor of the dismal macro facts.