Contents
List of fi gures vii
List of tables and boxes viii
List of acronyms and symbols ix
Foreword xii
Introduction 1
1 Asset models 5
1.1 Introduction 5
1.2 Global monetarism 8
1.3 Monetary models 9
1.4 Portfolio models 27
1.5 Conclusion 37
Appendix 1.1 Jensen’s inequality and Siegel’s paradox 38
2 IS/LM for an open economy 40
2.1 The basic model 40
2.2 Macroeconomic policy in a fi xed-but-adjustable peg system 43
2.3 Macroeconomic policy with free-fl oating exchange rates 55
2.4 Portfolio analysis and international capital movements 64
2.5 Overshooting 67
Appendix 2.1 Limitations and variants 69
Appendix 2.2 Devaluation, the trade balance and the terms
of trade 74
3 Dependent-economy models 80
3.1 The Australian two-sector model 80
3.2 The balance of payments in a fi xed-peg system 82
3.3 Flexible exchange rates 96
3.4 Adding a third good 104
4 The long and very long periods 107
4.1 The long period 107
4.2 Purchasing power parity 115
v
vi A guide to international monetary economics
4.3 The very long period 122
4.4 Conclusion 122
5 Exchange-rate policy 123
5.1 Introduction 123
5.2 Exchange-rate system and exchange-rate policy 124
5.3 Current-account disequilibria and capital-market integration 141
5.4 Policy coordination 148
5.5 Payments restrictions 159
5.6 Payments liberalisation 166
5.7 Conclusions 178
6 Monetary unions 180
6.1 What is a monetary union and what is the use of it? 180
6.2 Disadvantages of monetary union 183
6.3 Optimum currency areas 189
6.4 Potential problems of monetary union 196
6.5 European monetary union 199
6.6 Offi cial dollarisation 212
6.7 Final observations 214
Appendix 6.1 Monetary unions in history 215
References 221
Index 251
Figures
1.1 Overshooting 20
1.2 Overshooting in the Frankel model 23
1.3 The rate of exchange and the demand for foreign bonds 31
2.1 Fiscal policy with LM steeper than EE 46
2.2 Fiscal policy with EE steeper than LM 47
2.3 Monetary policy with fully interest-elastic capital flows 49
2.4 Monetary policy with IS between LM and EE 50
2.5 Monetary policy with fully interest-elastic capital flows and
free-floating exchange rates 59
2.6 Stock and flow effects 67
3.1 The equilibrium condition for the nontradeables market 84
3.2 The equilibrium condition for the tradeables market 85
3.3 Full equilibrium 86
3.4 The Salter diagram with a current-account deficit 95
3.5 The dependent-economy model with free-floating exchange
rates 98
3.6 A demand shock for tradeables 99
3.7 A demand shock for nontradeables 100
3.8 A demand shock for tradeables with perfect capital mobility 102
3.9 A demand shock for nontradeables with perfect capital
mobility 102
3.10 An increase in the rate of interest with perfect capital mobility 103
4.1 Portfolio adjustment and the rate of exchange 110
4.2 A higher propensity to spend on nontradeables in the
dependent economy with fixed exchange rates 113
4.3 The dependent-economy model with free-floating exchange
rates and capital inflows 114
5.1 Devaluation with overlapping bands 136
5.2 lntertemporal substitution with initial capital exports 143
5.3 Capital reallocation in a two-country world 145
5.4 Welfare effects of payments restrictions 160
vii
Tables and boxes
TABLES
3.1 The differences between the IS/LM/EE model and the
dependent-economy model 82
4.1 The hamburger standard 121
5.1 Countries with a currency board 131
5.2 Exchange-rate regimes, all countries, 1991 and 1999 139
5.3 Foreign-exchange market intervention and sterilisation by the
central bank in the case of a surplus in international payments 153
5.4 Average black-market premium in 41 developing countries 165
6.1 Creation of base money through government borrowing from
the central bank 185
6.2 Creation of base money through sales of assets to the central
bank 185
6.3 Relative economic size and relative use of currencies:
United States, Japan and euro area 211
6.4 Relative use of currencies: United States, Japan and
euro area, 1998 and 2001 211
BOXES
1.1 Real interest rate parity 15
2.1 Base money creation 42
2.2 Effects of monetary and fiscal policies with fully
interest-elastic capital flows 60
4.1 The consequences of higher investments by Japan in the
European Union 111
5.1 Foreign-exchange speculation and the short rate of interest 151