Current Issues in International Monetary Economics Current Issues in Economics

CURRENT ISSUES IN INTERNATIONAL MONETARY ECONOMICS CURRENT ISSUES IN ECONOMICS

General Editor: David Greenaway, University of Nottingham

Vol. I Current Issues in Microeconomics Edited by John D. Hey, University of York

Vol. 2 Current Issues in Macroeconomics Edited by David Greenaway, University of Nottingham

Vol. 3 Current Issues in Labour Economics Edited by David Sapsford, University of East Anglia, and Zafiris Tzannatos, University of Buckingham

Vol. 4 Current Issues in International Monetary Economics Edited by David T. Llewellyn and Chris Milner, Loughborough University

Forthcoming Vol. 5 Current Issues in Public Sector Economics Edited by Peter Jackson, University of Leicester

Vol. 6 Current Issues in Development Economics Edited by V. N. Balusubramanyam, University of Leicester, and S. Lall, University of Oxford

Vol. 7 Current Issues in Industrial Economics Edited by John Cable, University College of Wales, Aberystwyth

Vol. 8 Current Issues in Monetary Economics Edited by K. Dowd and Mervyn K. Lewis, University of Nottingham

Vol. 9 Current Issues in Welfare Economics Current Issues in International Monetary Economics

Edited by

David Llewellyn Professor of Money and Banking Loughborough University

and

Chris Milner Reader in Economics Loughborough University

St. Martin's Press New York Selection and editorial matter© David T. Llewellyn and Chris Milner 1990 Individual chapters © David T. Llewelyn and Chris Milner; Rodger Dornbusch; Michael Beenstock; Ronald MacDonald; Colin Kearney; David Currie; Andrew Dean; Nick Snowden; Robert Z. Aliber; and David T. Llewelyn 1990 Softcover reprint of the hardcover 1st edition 1990 978-0-333-45349-0

First published in the United States of America in 1990

ISBN 978-0-333-45350-6 ISBN 978-1-349-20983-5 (eBook) DOI 10.1007/978-1-349-20983-5 Library of Congress Cataloging-in-Publication Data Current issues in international monetary economics/edited by David Llewellyn and Chris Milner. p. cm.-(Current issues in economics; vol. 4) Includes bibliographical references. I. Foreign exchange. 2. International finance. 3. Monetary policy. I. Llewellyn, David T. II. Milner, Chris. III. Series. HG3851.C79 1990 332'.042-dc20 90-8101 CIP Contents

LIST OF FIGURES Vll

LIST OF TABLES lX

SERIES EDITOR'S PREFACE X

NOTES ON THE CONTRIBUTORS xii

Introduction: Current Issues and the Structure of the Book David T. Llewellyn and Chris Milner

2 Exchange Rate Economics Rudiger Dornbusch 13

3 Exchange Rate Dynamics Michael Beenstock 44

4 Empirical Studies of Exchange Rate Determination Ronald MacDonald 63

5 Stabilisation Policy with Flexible Exchange Rates Colm Kearney I 0 I

6 International Policy Coordination David Currie 125

7 Domestic and International Financial Imbalances and Adjustment Andrew Dean 149

v Vl Contents

8 The Analysis of International Debt Nick Snowden 175

9 Exchange Rate Arrangements Robert Z. A/iber 196 lO The International Monetary System David T. Llewellyn 213

END-NOTES 243

BIBLIOGRAPHY 247

NAME INDEX 266

SUBJECT INDEX 270 List of Figures

2.1 The real exchange rate effect of a transitory fiscal expansion 18 2.2 Canada-US real exchange rate changes (per cent per month) 24 2.3 Canada-US real exchange rate (index 1980 = I 00) 26 2.4 US-German real exchange rate (CPI index 1980= 100) 27 2.5 Forecast errors (percentages) 28 2.6 Japanese export prices (index 1985: 2= 100) 32 2.7 Capital goods prices (index 1980: I = I 00) 33 2.8 Real commodity prices (index 1980 = 100) 36 2.9 Real exchange rate movements and the real prices of commodities 37 4.1 Major industrial countries: quarterly real effective exchange rates, 1961-83 71 4.2 Major industrial countries: monthly nominal effective exchange rates, 1961-83 73 4.3 Contemporaneous spot and forward rates: (a) dollar-pound; (b) dollar-mark 75 4.4 The forward rate as a predictor of the spot rate: (a) dollar-pound: (b) dollar-mark 76 4.5 The forward premium and the percentage change in the exchange rate: (a) dollar-pound; (b) dollar-Mark 77 5.1 Stabilisation policy in the simple 'postulated' model 106 5.2 Stabilisation policy in the optimising model with Keynesian unemployment and perfect capital mobility 119 6.1 Hamada diagram 127

vii viii List of Figures

6.2 The consequences of European fiscal precommitment 128 8.1 Credit rationing and 'concerted' lending 187 10.1(a) Long-term nominal interest differential 231 10.1(b) US current account 231 10.2 US net international investment position 239 List of Tables

2.1 Variability of real exchange rates (coefficient of variation, monthly data) 25 2.2 Frankel-Froot dollar-yen data (per cent per year, sample average) 29 2.3 The effect of budget deficits on the current account

(REX=ao+a1 (r*-r)+a2b+a3b*) 30

3.1 Illustrative exchange rate dynamic (S0 = 0) 59 4.1 Minimum and maximum monthly percentage exchange rate changes 65 4.2 Standard deviations of monthly percentage changes in the exchange rate and other macroeconomic variables 67 5.1 A simple 'postulated' open economy macromodel 104 5.2 An optimising open economy macromodel 118 5.3 Stabilisation policy in 'postulated' and optimising open economy models with perfect capital mobility 121 7.1 The evolution of current-account imbalances 164 8.1 Current-account balances as a percentage of GNP in selected groups of countries, 1970-82 177 8.2 LDC net resource inflow by source and stock of outstanding debt 1970 and 1982 ($ billions in current values) 178 10.1 Current account imbalances ($billion) 227 10.2 Global reserve developments ($ billion) 236 10.3 Currency composition of foreign exchange reserves (percentage of total) 237

IX Series Editor's Preface

The Current Issues Series has slightly unusual origins. Current Issues in International Trade, which Macmillan published in 1987 and which turned out to be the pilot for the series was in fact 'conceived' in the Horton Hospital, Banbury, and 'delivered' (in the sense of completed) in the Hilton International in Nicosia! The reader may be struck by the thought that a more worthwhile and enjoyable production process would start and finish the other way around. I agree! Be that as it may, that is how the series started. As I said in the Preface to Current Issues in International Trade the reason for its creation was the difficulty of finding suitable references on 'frontier issues' for undergraduate students. Many of the issues which excite professional economists and which dominate the jour• nal literature take quite a time to percolate down into texts, hence the need for a volume of Current Issues. The reception which Current Issues in International Trade received persuaded me that it may be worth doing something similar for other subject areas we teach. Macmillan agreed with my judgement, hence the series. Thus each volume in this series is intended to take readers to the 'frontier' of the particular subject area. Each volume contains ten essays, nine of which deal with specific current issues, and one which provides a general overview, setting the relevant current issues in the context of other recent developments. As Series Editor the main challenge I faced was finding suitable editors for each of the volumes- the best people are generally the busiest! I believe however that I have been fortunate in having such an impressive and experienced team of editors with the necessary skills and reputation to persuade first-class authors to participate. I would like to thank all of them for their cooperation and assistance in the development of the series. Like me all of them will, I am sure,

X Series Editor's Preface XI

hope that this series provides a useful service to undergraduate and postgraduate students as well as faculty. With regard to the present volume, we know that international monetary economics has been an area of profound change in recent years. As the Editors acknowledge in their introduction, this has been fashioned partly by institutional developments (such as the globalisation of asset markets and the shift to flexible exchange rates), and partly by 'technical change' in the economics profession. Consequently the issues which preoccupy analysts in this area, and the way in which they think about those issues has altered markedly. These changes are captured well in this volume. The issues covered include the modelling of exchange rate dynamics, empirical aspects of exchange rate movements, policy coordination, and international debt. The Editors are to be commended on their choice of topics. They have provided us with a well balanced blend of theory, empirics and policy analysis- a blend which conveys the richness and excitement of current issues in international monetary eco• nomics. The authors are also to be congratulated on producing essays of such a consistently high standard. The issues addressed are often complex yet the authors have still managed to provide us with a digestible volume. I have enjoyed working on this volume and have certainly learned from it. I hope others have a similar experience.

DAVID GREENAWAY University of Nottingham Notes on the Contributors

Robert Aliber is Professor of International Economics and Finance, University of Chicago.

Michael Beenstock is Professor of Economics, The Hebrew Univer• sity of Jerusalem.

David Currie is Professor of Economics and Director of the Centre for Economic Forecasting, London Business School.

Andrew Dean is in the Balance of Payments Division of the Organi• sation for Economic Cooperation and Development.

Rudiger Dornbusch is Professor of Economics, Massachusetts Insti• tute of Technology.

Colm Kearney is Lecturer in Economics, University of New South Wales.

David T. Llewellyn is Professor of Money and Banking, Loughbor• ough University.

Ronald MacDonald is Professor of Economics, University of Dun• dee.

Chris Milner is Reader in Economics, Loughborough University.

Nick Snowden is Lecturer in Economics, University of Lancaster.

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