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The Capitalization of Income Streams and the Effects of Open Market Policy under Fixed Exchange Rates

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  • Maurice Obstfeld

Abstract

This paper investigates the long- and short-run neutrality of open-market monetary policy in a world of fixed exchange rates and imperfect substitutability between bonds denominated in different currencies. Using an illustrative portfolio-balance model, it shows that when the public discounts the future tax liabilities associated with the national debt and the central bank supports the exchange rate by trading non-interest-bearing foreign assets, open-market policy has a short-run effect, but no long-run effect, on the domestic price level and interest rate. When the foreign-exchange intervention assets earn interest that is rebated to and capitalized by the public, open-market policy loses even its short-run efficacy -- the capital-account offset to monetary policy is complete.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0528.

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Date of creation: Aug 1980
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Publication status: published as Obstfeld, Maurice. "The Capitalization of Income Streams and the Effects of Open Market Policy under Fixed Exchange Rates." Journal of Monetary Economics. Vol. 9, No. 1, (January 1982), pp. 87- 98.
Handle: RePEc:nbr:nberwo:0528

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  1. Robert A. Mundell, 1960. "The Public Debt, Corporate Income Taxes, and the Rate of Interest," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 68, pages 622.
  2. Kouri, Pentti J K & Porter, Michael G, 1974. "International Capital Flows and Portfolio Equilibrium," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 82(3), pages 443-67, May/June.
  3. Barro, Robert J, 1974. "Are Government Bonds Net Wealth?," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 82(6), pages 1095-1117, Nov.-Dec..
  4. Frenkel, Jacob A & Rodriguez, Carlos Alfredo, 1975. "Portfolio Equilibrium and the Balance of Payments: A Monetary Approach," American Economic Review, American Economic Association, American Economic Association, vol. 65(4), pages 674-88, September.
  5. Russell S. Boyer, 1975. "Commodity Markets and Bond Markets in a Small, Fixed-Exchange-Rate Economy," Canadian Journal of Economics, Canadian Economics Association, Canadian Economics Association, vol. 8(1), pages 1-23, February.
  6. Boyer, Russel S., 1979. "Sterilization and the monetary approach to balance of payments analysis," Journal of Monetary Economics, Elsevier, Elsevier, vol. 5(2), pages 295-300, April.
  7. Henderson, Dale W, 1977. "Modeling the Interdependence of National Money and Capital Markets," American Economic Review, American Economic Association, American Economic Association, vol. 67(1), pages 190-99, February.
  8. Girton, Lance & Henderson, Dale W., 1976. "Financial capital movements and central bank behavior in a two-country, short-run portfolio balance model," Journal of Monetary Economics, Elsevier, Elsevier, vol. 2(1), pages 33-61, January.
  9. Obstfeld, Maurice, 1980. "Imperfect asset substitutability and monetary policy under fixed exchange rates," Journal of International Economics, Elsevier, Elsevier, vol. 10(2), pages 177-200, May.
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Cited by:
  1. Stijn van Nieuwerburgh & Michael Kumhof, 2005. "Monetary Policy in an Equilibrium Portfolio Balance Model," 2005 Meeting Papers, Society for Economic Dynamics 851, Society for Economic Dynamics.
  2. Maurice Obstfeld, 1980. "Imperfect Asset Substitutability and Monetary Policy under Fixed Exchange Rates," NBER Working Papers 0485, National Bureau of Economic Research, Inc.
  3. David K. Backus & Patrick J. Kehoe, 1988. "On the denomination of government debt: a critique of the portfolio balance approach," Staff Report, Federal Reserve Bank of Minneapolis 116, Federal Reserve Bank of Minneapolis.
  4. Maurice Obstfeld, 1982. "Exchange Rates, Inflation and the Sterilization Problem: Germany, 1975-1981," NBER Working Papers 0963, National Bureau of Economic Research, Inc.
  5. Kumhof, Michael, 2010. "On the theory of sterilized foreign exchange intervention," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 34(8), pages 1403-1420, August.
  6. Christelle Lecourt & Helene Raymond, 2006. "Central bank interventions in industrialized countries: a characterization based on survey results," International Journal of Finance & Economics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 11(2), pages 123-138.

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