International Monetary Economics
2. National income accounting and the balance of payments 7
1. Introduction 7
2. The national income accounts 7
2.1. National product and national income 7
2.2. Capital depreciation and international transfers 8
2.3. Gross domestic product 8
3. National income accounting for an open economy 8
3.1. The national income identity for an open economy 8
3.2. The current account and foreign indebtedness 9
3.3. Global imbalances 11
3.4. Saving and the current account 12
3.5. Private and government saving 12
4. The balance of payments accounts 13
4.1. The fundamental balance of payments identity 14
4.2. The current account, once again 14
4.3. The capital account 14
4.4. Statistical discrepancy 14
4.5. Official reserve transactions 14
4.6. Capital flows and exchange rates 15
5. Takeways 16
3. Exchange rates and the foreign exchange market: an asset approach 17
1. Exchange rate and international transactions 17
2. The foreign exchange market 18
2.1. The actors 18
2.2. Characteristics of the market 18
2.3. International nature of currencies 19
2.4. Spot rates and forward rates 20
3. The demand for foreign currency assets 20
4. Equilibrium in the foreign exchange market 21
4.1. The effect of changing interest rates on the current exchange rate 22
4.2. The effect of changing expectations on the current exchange rate 23
5. Extra slides 23
6. Takeaways 25
4. Money, interest rates and exchange rates 26
1. Money de ned: a brief review 26
1.1. Money as a medium of exchange 26
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, 1.2. Money as a unit of account 26
1.3. Money as a store of value 26
1.4. What is money? 26
1.5. How the money supply is determined 27
2. The demand for money by individuals 27
2.1. Expected return 27
2.2. Risk 27
2.3. Liquidity 27
3. Aggregate money demand 27
4. The equilibrium interest rate: the interaction of money supply and demand 29
4.1. Equilibrium in the money market 29
4.2. Interest rates and the money supply 30
4.3. Output and the interest rate 30
5. The money supply and the exchange rate in the short run 31
5.1. Linking money, the interest rate and the exchange rate 31
5.2. US money supply and the dollar/euro exchange rate 32
5.3. Europe’s money supply and dollar/euro exchange rate 33
6. Money, the price level, and the exchange rate in the long run 34
6.1. Money and money prices 34
6.2. The long-run effects of money supply changes 34
6.3. Empirical evidence on money supplies and price levels 34
6.4. Money and the exchange rate in the long run 35
7. In ation and exchange rate dynamics 35
7.1. Short-run price rigidity versus long-run price flexibility 35
7.2. Permanent money supply changes and the exchange rate 36
7.3. Exchange rate overshooting 37
8. Takeaways 38
5. Price levels and the exchange rate in the long run 39
1. The law of one price 39
2. Purchasing power parity 41
2.1. The relationship between PPP and the law of one price 41
2.2. Absolute PPP and relative PPP 41
3. A long-run exchange rate model based on PPP 41
3.1. The fundamental equation of the monetary approach 41
3.2. The Fisher effect 43
4. Empirical evidence on PPP and the law of one price 44
5. Explaining the problems with PPP 45
5.1. Trade barriers and nontradeables 46
5.2. Departures from free competition 46
5.3. Differences in consumption patterns and price level measurement 46
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, 6. Beyond purchasing power parity: a general model of long-run exchange rates 46
6.1. The real exchange rate 46
6.2. Demand, supply and the long-run real exchange rate 47
6.3. Nominal and real exchange rates in long-run equilibrium 48
7. Takeaways 50
Chapter 6: Output and the exchange rate in the short run 51
1. Determinants of aggregate demand in an open economy 51
1.1. Determinants of consumption demand 51
1.2. Determinants of the current account 51
1.3. How real exchange rate changes affect the current account 52
1.4. How disposable income changes affect the current account 52
2. The equation of aggregate demand 52
2.1. The real exchange rate and aggregate demand 52
2.2. Real income and aggregate demand 53
3. How output is determined in the short run 53
4. Output market equilibrium in the short run: the DD schedule 54
4.1. Output, the exchange rate, and output market equilibrium 54
4.2. Deriving the DD schedule 54
4.3. Factors that shift the DD schedule 55
5. Asset market equilibrium in the short run: the AA schedule 55
5.1. Output, the exchange rate and asset market equilibrium 55
5.2. Deriving the AA schedule 55
6. Short-run equilibrium for an open economy: putting the DD and AA schedules together56
7. Temporary changes in monetary and scal policy 57
7.1. Monetary policy 57
7.2. Fiscal policy 59
7.3. Policies to maintain full employment 60
8. In ation bias and other problems of policy formulation 61
9. Permanent shifts in monetary and scal policy 62
9.1. A permanent increase in the money supply 62
9.2. Adjustment to a permanent increase in the money supply 63
9.3. A permanent fiscal expansion 64
10. Macroeconomic policies and the current account 65
11. Gradual trade ow adjustment and current account dynamics 65
11.1.The J-curve 66
11.2.Exchange rate pass-through and inflation 66
11.3.The current account, wealth and exchange rate dynamics 66
12. The liquidity trap 66
13. Takeaways 68
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, Chapter 7: Fixed exchange rates and foreign exchange intervention 69
1. Central bank intervention and the money supply 69
1.1. The central bank balance sheet and the money supply 69
1.2. Foreign exchange intervention and the money supply 70
1.3. Sterilisation 70
1.4. The balance of payments and the money supply 71
2. How the central bank xes the exchange rate 71
2.1. Foreign exchange market equilibrium under a fixed exchange rate 71
2.2. Money market equilibrium under a fixed exchange rate 71
2.3. A diagrammatic analysis 72
3. Stabilisation policies with a xed exchange rate 72
3.1. Monetary policy 72
3.2. Fiscal policy 72
3.3. Changes in the exchange rate 73
3.4. Adjustment to fiscal policy and exchange rate changes 74
4. Balance of payments crisis and capital ight 74
5. Managed oating and sterilised intervention 75
5.1. Perfect asset substitutability and the ineffectiveness of sterilised intervention 75
5.2. Foreign exchange market equilibrium under imperfect asset substitutability 76
5.3. The effects of sterilised intervention with imperfect asset substitutability 76
5.4. Effectiveness of non-sterilised intervention 76
5.5. Managed floating 76
6. Reserve currencies in the world monetary systems 77
6.1. The mechanics of a reserve currency standard 77
6.2. The asymmetric position of the reserve centre 77
7. The gold standard 78
7.1. The mechanics of a gold standard 78
7.2. Symmetric monetary adjustment under a gold standard 78
7.3. Benefits and drawbacks of the gold standard 78
8. Takeaways 79
Chapter 8: International monetary systems: an historical overview 80
1. Macroeconomic policy goals in an open economy 80
1.1. Internal balance: full employment and price level stability 80
1.2. External balance: the optimal level if the current account 80
1.2.1.Problems with excessive current account deficits 80
1.2.2.Problems with excessive current account surpluses 80
2. Classifying monetary systems: the open-economy monetary trilemma 81
3. International macroeconomic policy under the gold standard, 1870-1914 81
3.1. External balance under the gold standard 81
3.2. The price-specie-flow mechanism 81
3.3. The gold standard “Rules of the game”: myth and reality 82
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2. National income accounting and the balance of payments 7
1. Introduction 7
2. The national income accounts 7
2.1. National product and national income 7
2.2. Capital depreciation and international transfers 8
2.3. Gross domestic product 8
3. National income accounting for an open economy 8
3.1. The national income identity for an open economy 8
3.2. The current account and foreign indebtedness 9
3.3. Global imbalances 11
3.4. Saving and the current account 12
3.5. Private and government saving 12
4. The balance of payments accounts 13
4.1. The fundamental balance of payments identity 14
4.2. The current account, once again 14
4.3. The capital account 14
4.4. Statistical discrepancy 14
4.5. Official reserve transactions 14
4.6. Capital flows and exchange rates 15
5. Takeways 16
3. Exchange rates and the foreign exchange market: an asset approach 17
1. Exchange rate and international transactions 17
2. The foreign exchange market 18
2.1. The actors 18
2.2. Characteristics of the market 18
2.3. International nature of currencies 19
2.4. Spot rates and forward rates 20
3. The demand for foreign currency assets 20
4. Equilibrium in the foreign exchange market 21
4.1. The effect of changing interest rates on the current exchange rate 22
4.2. The effect of changing expectations on the current exchange rate 23
5. Extra slides 23
6. Takeaways 25
4. Money, interest rates and exchange rates 26
1. Money de ned: a brief review 26
1.1. Money as a medium of exchange 26
1
fi
, 1.2. Money as a unit of account 26
1.3. Money as a store of value 26
1.4. What is money? 26
1.5. How the money supply is determined 27
2. The demand for money by individuals 27
2.1. Expected return 27
2.2. Risk 27
2.3. Liquidity 27
3. Aggregate money demand 27
4. The equilibrium interest rate: the interaction of money supply and demand 29
4.1. Equilibrium in the money market 29
4.2. Interest rates and the money supply 30
4.3. Output and the interest rate 30
5. The money supply and the exchange rate in the short run 31
5.1. Linking money, the interest rate and the exchange rate 31
5.2. US money supply and the dollar/euro exchange rate 32
5.3. Europe’s money supply and dollar/euro exchange rate 33
6. Money, the price level, and the exchange rate in the long run 34
6.1. Money and money prices 34
6.2. The long-run effects of money supply changes 34
6.3. Empirical evidence on money supplies and price levels 34
6.4. Money and the exchange rate in the long run 35
7. In ation and exchange rate dynamics 35
7.1. Short-run price rigidity versus long-run price flexibility 35
7.2. Permanent money supply changes and the exchange rate 36
7.3. Exchange rate overshooting 37
8. Takeaways 38
5. Price levels and the exchange rate in the long run 39
1. The law of one price 39
2. Purchasing power parity 41
2.1. The relationship between PPP and the law of one price 41
2.2. Absolute PPP and relative PPP 41
3. A long-run exchange rate model based on PPP 41
3.1. The fundamental equation of the monetary approach 41
3.2. The Fisher effect 43
4. Empirical evidence on PPP and the law of one price 44
5. Explaining the problems with PPP 45
5.1. Trade barriers and nontradeables 46
5.2. Departures from free competition 46
5.3. Differences in consumption patterns and price level measurement 46
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, 6. Beyond purchasing power parity: a general model of long-run exchange rates 46
6.1. The real exchange rate 46
6.2. Demand, supply and the long-run real exchange rate 47
6.3. Nominal and real exchange rates in long-run equilibrium 48
7. Takeaways 50
Chapter 6: Output and the exchange rate in the short run 51
1. Determinants of aggregate demand in an open economy 51
1.1. Determinants of consumption demand 51
1.2. Determinants of the current account 51
1.3. How real exchange rate changes affect the current account 52
1.4. How disposable income changes affect the current account 52
2. The equation of aggregate demand 52
2.1. The real exchange rate and aggregate demand 52
2.2. Real income and aggregate demand 53
3. How output is determined in the short run 53
4. Output market equilibrium in the short run: the DD schedule 54
4.1. Output, the exchange rate, and output market equilibrium 54
4.2. Deriving the DD schedule 54
4.3. Factors that shift the DD schedule 55
5. Asset market equilibrium in the short run: the AA schedule 55
5.1. Output, the exchange rate and asset market equilibrium 55
5.2. Deriving the AA schedule 55
6. Short-run equilibrium for an open economy: putting the DD and AA schedules together56
7. Temporary changes in monetary and scal policy 57
7.1. Monetary policy 57
7.2. Fiscal policy 59
7.3. Policies to maintain full employment 60
8. In ation bias and other problems of policy formulation 61
9. Permanent shifts in monetary and scal policy 62
9.1. A permanent increase in the money supply 62
9.2. Adjustment to a permanent increase in the money supply 63
9.3. A permanent fiscal expansion 64
10. Macroeconomic policies and the current account 65
11. Gradual trade ow adjustment and current account dynamics 65
11.1.The J-curve 66
11.2.Exchange rate pass-through and inflation 66
11.3.The current account, wealth and exchange rate dynamics 66
12. The liquidity trap 66
13. Takeaways 68
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, Chapter 7: Fixed exchange rates and foreign exchange intervention 69
1. Central bank intervention and the money supply 69
1.1. The central bank balance sheet and the money supply 69
1.2. Foreign exchange intervention and the money supply 70
1.3. Sterilisation 70
1.4. The balance of payments and the money supply 71
2. How the central bank xes the exchange rate 71
2.1. Foreign exchange market equilibrium under a fixed exchange rate 71
2.2. Money market equilibrium under a fixed exchange rate 71
2.3. A diagrammatic analysis 72
3. Stabilisation policies with a xed exchange rate 72
3.1. Monetary policy 72
3.2. Fiscal policy 72
3.3. Changes in the exchange rate 73
3.4. Adjustment to fiscal policy and exchange rate changes 74
4. Balance of payments crisis and capital ight 74
5. Managed oating and sterilised intervention 75
5.1. Perfect asset substitutability and the ineffectiveness of sterilised intervention 75
5.2. Foreign exchange market equilibrium under imperfect asset substitutability 76
5.3. The effects of sterilised intervention with imperfect asset substitutability 76
5.4. Effectiveness of non-sterilised intervention 76
5.5. Managed floating 76
6. Reserve currencies in the world monetary systems 77
6.1. The mechanics of a reserve currency standard 77
6.2. The asymmetric position of the reserve centre 77
7. The gold standard 78
7.1. The mechanics of a gold standard 78
7.2. Symmetric monetary adjustment under a gold standard 78
7.3. Benefits and drawbacks of the gold standard 78
8. Takeaways 79
Chapter 8: International monetary systems: an historical overview 80
1. Macroeconomic policy goals in an open economy 80
1.1. Internal balance: full employment and price level stability 80
1.2. External balance: the optimal level if the current account 80
1.2.1.Problems with excessive current account deficits 80
1.2.2.Problems with excessive current account surpluses 80
2. Classifying monetary systems: the open-economy monetary trilemma 81
3. International macroeconomic policy under the gold standard, 1870-1914 81
3.1. External balance under the gold standard 81
3.2. The price-specie-flow mechanism 81
3.3. The gold standard “Rules of the game”: myth and reality 82
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