SUMMARY: INTERNATIONAL
MONETARY ECONOMICS
2020-2021
LEO VAN HOVE
,Inhoudsopgave
Introduction .................................................................................................................................................. 3
Exam parts: ........................................................................................................................................................ 3
Chapter 2: National Income Accounting and the Balance of Payments ........................................................... 3
Modules ............................................................................................................................................................. 3
A. Introduction ........................................................................................................................................... 3
B. National income identity .................................................................................................................... 5
C. Breaking down GDP ............................................................................................................................ 6
D. Implications of running a CA deficit ............................................................................................. 11
E. CA deficit and foreign debt: a qualification ................................................................................ 15
F. Global imbalances ............................................................................................................................. 18
G. CA imbalances and national saving ............................................................................................. 21
H. The balance of payments accounts: main principles .............................................................. 25
I. BOP accounts: details ....................................................................................................................... 31
K. Capital Flows and exchange rates ................................................................................................ 36
L. Problems (and how to solve them) ................................................................................................ 36
Q&A .................................................................................................................................................................. 40
Chapter 3: Exchange Rates and the Foreign Exchange market: An asset approach ........................................ 42
Modules ........................................................................................................................................................... 42
A. Introduction ......................................................................................................................................... 42
B. Exchange rates .................................................................................................................................. 42
C. The foreign exchange market ......................................................................................................... 47
D. Derivation of the model .................................................................................................................... 53
E. Graphical presentation of the model ............................................................................................ 56
F. Using the model ................................................................................................................................. 58
G. More on expectations ....................................................................................................................... 61
H. Extra slides.......................................................................................................................................... 64
Chapter 4: Money, Interest rates and exchange rates................................................................................... 67
Modules ........................................................................................................................................................... 67
A. Introduction ......................................................................................................................................... 67
C. Short-run model for the money market ....................................................................................... 71
D. Money market + Foreign exchange market................................................................................. 72
E. A glimpse of the long run ................................................................................................................ 76
F. Short + long run ................................................................................................................................. 78
Chapter 5: Price levels and the exchange rate in the long run ....................................................................... 81
Modules ........................................................................................................................................................... 81
A. Introduction ......................................................................................................................................... 81
B. Law of one price + PPP .................................................................................................................... 82
C. The monetary approach ................................................................................................................... 86
D. Empirical evidence ............................................................................................................................ 89
E. Real exchange rate ............................................................................................................................ 91
F. General(ised)model ........................................................................................................................... 95
Chapter 6: Output and the exchange rate in the short run............................................................................ 98
Modules ........................................................................................................................................................... 98
A. Introduction ......................................................................................................................................... 98
B. Overview of exchange rate models............................................................................................... 99
C. Output market ................................................................................................................................... 100
1
, D. Derivation of DD-curve ................................................................................................................... 104
E. Derivation of AA-curve ................................................................................................................... 107
F. The DD-AA model............................................................................................................................. 110
G. Temporary policy measures (no long-run, no expectations) ............................................... 111
H. (Temporary) shocks ........................................................................................................................ 116
I. Policy formulation in practice ........................................................................................................ 118
J. Permanent policy measures .......................................................................................................... 119
K. DD-AA-XX .......................................................................................................................................... 125
L. Current account dynamics ............................................................................................................ 126
M. Liquidity trap .................................................................................................................................... 129
N. DD-AA questions and how to solve them ................................................................................. 133
Chapter 7: Fixed Exchange Rates and Foreign Exchange Intervention ......................................................... 136
Modules........................................................................................................................................................ 136
A. Introduction ....................................................................................................................................... 136
B. Balance sheet of the central bank ............................................................................................... 136
C. Foreign exchange intervention .................................................................................................... 138
D. DD-AA under fixed exchange rates............................................................................................. 144
E. BOP crises ......................................................................................................................................... 147
F. Effectiveness of intervention ........................................................................................................ 149
G. Exchange rate systems ................................................................................................................. 152
Chapter 8: International Monetary Systems: An Historical Overview .......................................................... 156
Modules........................................................................................................................................................ 156
A. Introduction ....................................................................................................................................... 156
B. Macroeconomic Policy Goals ....................................................................................................... 157
C. The Gold Standard .......................................................................................................................... 159
D. The Interwar Years .......................................................................................................................... 161
E. The Bretton Woods System .......................................................................................................... 162
G. Floating or Fixed Exchange Rates? ........................................................................................... 170
H. Foreign Exchange Markets Since 1973 ...................................................................................... 173
I. Macroeconomic Interdependence Under Floating Exchange Rates + Appendix ............. 174
Chapter 10: Optimum Currency Areas and the Euro ................................................................................... 177
Modules........................................................................................................................................................ 177
A. Introduction ....................................................................................................................................... 177
B. A Chronicle of European Monetary Integration ....................................................................... 178
C. Motivations ........................................................................................................................................ 182
D. GG-LL ................................................................................................................................................. 183
E. Is the Eurozone an OCA? .............................................................................................................. 188
F. The Euro Crisis ................................................................................................................................. 194
Euroland: Promised Land or Monetary Atlantis? ........................................................................................ 198
Modules........................................................................................................................................................ 198
A. Introduction ....................................................................................................................................... 198
B. Organisation ..................................................................................................................................... 198
C. Mandate .............................................................................................................................................. 200
D. Strategy .............................................................................................................................................. 203
E. Instruments ....................................................................................................................................... 209
F. The external value of the euro in 1999-2000 ............................................................................. 214
2
, Introduction
Exam question:
- Picture of day before and we have to say what happened. Mostly ‘why’
questions. Which model do you use here? Which problem do you see?
- A newspaper article with a shock or policy, he will ask to use the DDAA model.
Additional question to make part if the analysis yourself.
Never learn lists by heart but know examples. Mostly indirectly, you have to be able
the most important instruments of the ECB for example.
Exam parts:
Chapter 2: National Income Accounting and the Balance of Payments
Modules
A. Introduction
There are two main parts to the chapter
- National income accounting
- Balance of payments account
We will play around with the national income identity, we will rewrite the identity,
rearrange the variables that appear in it to highlight a number of important links
between the variables. NI = GNP
But first: we need to explain or justify the identity.
By definition, the identity tells you that the National Income should equal National
Product.
National Income Accounts (NI = GNP)
National income (NI)
- Record the value of national income that results from production and
expenditure (We see already that there are two possible angles to compute
national income or GNP The production angle or an expenditure angle)
o National income is often defined to be the income earned by a nation’s
factors of production.
Factors of production = capital & labour & eventually information
Nation’s factors (see and module; difference cross national and
domestic product)
3
MONETARY ECONOMICS
2020-2021
LEO VAN HOVE
,Inhoudsopgave
Introduction .................................................................................................................................................. 3
Exam parts: ........................................................................................................................................................ 3
Chapter 2: National Income Accounting and the Balance of Payments ........................................................... 3
Modules ............................................................................................................................................................. 3
A. Introduction ........................................................................................................................................... 3
B. National income identity .................................................................................................................... 5
C. Breaking down GDP ............................................................................................................................ 6
D. Implications of running a CA deficit ............................................................................................. 11
E. CA deficit and foreign debt: a qualification ................................................................................ 15
F. Global imbalances ............................................................................................................................. 18
G. CA imbalances and national saving ............................................................................................. 21
H. The balance of payments accounts: main principles .............................................................. 25
I. BOP accounts: details ....................................................................................................................... 31
K. Capital Flows and exchange rates ................................................................................................ 36
L. Problems (and how to solve them) ................................................................................................ 36
Q&A .................................................................................................................................................................. 40
Chapter 3: Exchange Rates and the Foreign Exchange market: An asset approach ........................................ 42
Modules ........................................................................................................................................................... 42
A. Introduction ......................................................................................................................................... 42
B. Exchange rates .................................................................................................................................. 42
C. The foreign exchange market ......................................................................................................... 47
D. Derivation of the model .................................................................................................................... 53
E. Graphical presentation of the model ............................................................................................ 56
F. Using the model ................................................................................................................................. 58
G. More on expectations ....................................................................................................................... 61
H. Extra slides.......................................................................................................................................... 64
Chapter 4: Money, Interest rates and exchange rates................................................................................... 67
Modules ........................................................................................................................................................... 67
A. Introduction ......................................................................................................................................... 67
C. Short-run model for the money market ....................................................................................... 71
D. Money market + Foreign exchange market................................................................................. 72
E. A glimpse of the long run ................................................................................................................ 76
F. Short + long run ................................................................................................................................. 78
Chapter 5: Price levels and the exchange rate in the long run ....................................................................... 81
Modules ........................................................................................................................................................... 81
A. Introduction ......................................................................................................................................... 81
B. Law of one price + PPP .................................................................................................................... 82
C. The monetary approach ................................................................................................................... 86
D. Empirical evidence ............................................................................................................................ 89
E. Real exchange rate ............................................................................................................................ 91
F. General(ised)model ........................................................................................................................... 95
Chapter 6: Output and the exchange rate in the short run............................................................................ 98
Modules ........................................................................................................................................................... 98
A. Introduction ......................................................................................................................................... 98
B. Overview of exchange rate models............................................................................................... 99
C. Output market ................................................................................................................................... 100
1
, D. Derivation of DD-curve ................................................................................................................... 104
E. Derivation of AA-curve ................................................................................................................... 107
F. The DD-AA model............................................................................................................................. 110
G. Temporary policy measures (no long-run, no expectations) ............................................... 111
H. (Temporary) shocks ........................................................................................................................ 116
I. Policy formulation in practice ........................................................................................................ 118
J. Permanent policy measures .......................................................................................................... 119
K. DD-AA-XX .......................................................................................................................................... 125
L. Current account dynamics ............................................................................................................ 126
M. Liquidity trap .................................................................................................................................... 129
N. DD-AA questions and how to solve them ................................................................................. 133
Chapter 7: Fixed Exchange Rates and Foreign Exchange Intervention ......................................................... 136
Modules........................................................................................................................................................ 136
A. Introduction ....................................................................................................................................... 136
B. Balance sheet of the central bank ............................................................................................... 136
C. Foreign exchange intervention .................................................................................................... 138
D. DD-AA under fixed exchange rates............................................................................................. 144
E. BOP crises ......................................................................................................................................... 147
F. Effectiveness of intervention ........................................................................................................ 149
G. Exchange rate systems ................................................................................................................. 152
Chapter 8: International Monetary Systems: An Historical Overview .......................................................... 156
Modules........................................................................................................................................................ 156
A. Introduction ....................................................................................................................................... 156
B. Macroeconomic Policy Goals ....................................................................................................... 157
C. The Gold Standard .......................................................................................................................... 159
D. The Interwar Years .......................................................................................................................... 161
E. The Bretton Woods System .......................................................................................................... 162
G. Floating or Fixed Exchange Rates? ........................................................................................... 170
H. Foreign Exchange Markets Since 1973 ...................................................................................... 173
I. Macroeconomic Interdependence Under Floating Exchange Rates + Appendix ............. 174
Chapter 10: Optimum Currency Areas and the Euro ................................................................................... 177
Modules........................................................................................................................................................ 177
A. Introduction ....................................................................................................................................... 177
B. A Chronicle of European Monetary Integration ....................................................................... 178
C. Motivations ........................................................................................................................................ 182
D. GG-LL ................................................................................................................................................. 183
E. Is the Eurozone an OCA? .............................................................................................................. 188
F. The Euro Crisis ................................................................................................................................. 194
Euroland: Promised Land or Monetary Atlantis? ........................................................................................ 198
Modules........................................................................................................................................................ 198
A. Introduction ....................................................................................................................................... 198
B. Organisation ..................................................................................................................................... 198
C. Mandate .............................................................................................................................................. 200
D. Strategy .............................................................................................................................................. 203
E. Instruments ....................................................................................................................................... 209
F. The external value of the euro in 1999-2000 ............................................................................. 214
2
, Introduction
Exam question:
- Picture of day before and we have to say what happened. Mostly ‘why’
questions. Which model do you use here? Which problem do you see?
- A newspaper article with a shock or policy, he will ask to use the DDAA model.
Additional question to make part if the analysis yourself.
Never learn lists by heart but know examples. Mostly indirectly, you have to be able
the most important instruments of the ECB for example.
Exam parts:
Chapter 2: National Income Accounting and the Balance of Payments
Modules
A. Introduction
There are two main parts to the chapter
- National income accounting
- Balance of payments account
We will play around with the national income identity, we will rewrite the identity,
rearrange the variables that appear in it to highlight a number of important links
between the variables. NI = GNP
But first: we need to explain or justify the identity.
By definition, the identity tells you that the National Income should equal National
Product.
National Income Accounts (NI = GNP)
National income (NI)
- Record the value of national income that results from production and
expenditure (We see already that there are two possible angles to compute
national income or GNP The production angle or an expenditure angle)
o National income is often defined to be the income earned by a nation’s
factors of production.
Factors of production = capital & labour & eventually information
Nation’s factors (see and module; difference cross national and
domestic product)
3
