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A Monetary Model of Exchange Rate and Balance of Payments Adjustment

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  • A J Makin

Abstract

This article proposes an alternative monetary model for examining the effects of domestic monetary shocks on the exchange rate and the balance of payments. Using an output-expenditure framework, it shows that domestic monetary shocks can drive a wedge between national expenditure and production and generate incipient current account imbalances with exchange rate and balance of payments implications. Contrary to previous monetary approaches, the model suggests a new chain of causality that runs from domestic money to the exchange rate to the price level, rather than from money to the price level to the exchange rate. It also shows that under fixed rates external adjustment is consistent with money market equilibrium and price level stability.

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Article provided by Economic Issues in its journal Economic Issues.

Volume (Year): 10 (2005)
Issue (Month): 1 (March)
Pages: 25-36

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Handle: RePEc:eis:articl:105makin

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  1. Giancarlo Corsetti & Paolo Pesenti, 2001. "Welfare And Macroeconomic Interdependence," The Quarterly Journal of Economics, MIT Press, vol. 116(2), pages 421-445, May.
  2. Frenkel, Jacob A, 1976. " A Monetary Approach to the Exchange Rate: Doctrinal Aspects and Empirical Evidence," Scandinavian Journal of Economics, Wiley Blackwell, vol. 78(2), pages 200-224.
  3. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1996. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," NBER Working Papers 5809, National Bureau of Economic Research, Inc.
  4. Johnson, Harry G., 1977. "The monetary approach to the balance of payments : A nontechnical guide," Journal of International Economics, Elsevier, vol. 7(3), pages 251-268, August.
  5. MacDonald, Ronald, 1999. "Exchange Rate Behaviour: Are Fundamentals Important?," Economic Journal, Royal Economic Society, vol. 109(459), pages F673-91, November.
  6. Rogoff, Kenneth, 1999. "Monetary Models of Dollar/Yen/Euro Nominal Exchange Rates: Dead or Undead?," Economic Journal, Royal Economic Society, vol. 109(459), pages F655-59, November.
  7. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  8. Bruce, Neil & Purvis, Douglas D., 1985. "The specification and influence of goods and factor markets in open-economy macroeconomic models," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 16, pages 807-857 Elsevier.
  9. Sachs, Jeffrey, 1982. " The Current Account in the Macroeconomic Adjustment Process," Scandinavian Journal of Economics, Wiley Blackwell, vol. 84(2), pages 147-59.
  10. J. J. Polak, 1957. "Monetary Analysis of Income Formation and Payments Problems," IMF Staff Papers, Palgrave Macmillan, vol. 6(1), pages 1-50, November.
  11. Sarno,Lucio & Taylor,Mark P., 2003. "The Economics of Exchange Rates," Cambridge Books, Cambridge University Press, number 9780521485845.
  12. Sidney S. Alexander, 1952. "Effects of a Devaluation on a Trade Balance," IMF Staff Papers, Palgrave Macmillan, vol. 2(2), pages 263-278, April.
  13. Anthony J. Makin, 2004. "The Current Account, Fiscal Policy, and Medium-Run Income Determination," Contemporary Economic Policy, Western Economic Association International, vol. 22(3), pages 309-317, 07.
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