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Exchange-Rate Policy After a Decade of "Floating"

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  • William H. Branson
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    Abstract

    This paper integrates exchange-rate policy into a model of exchange- rate behavior, and examines the data econometrically to infer hypotheses about policy behavior in the 1970s. The model shows how unanticipated movements in money, the current account, and relative price levels will cause first a jump in the exchange rate, and then a movement along a "saddle path" to the new long run equilibrium. Here the role of "news" in moving the exchange rate is clear. The model is used to analyze the options available to the central bank that wants to reduce the jump in the exchange rate following a real or monetary disturbance. The distinction is made between monetary policy and sterilized intervention, and a regime in which the domestic interest rate is used as the policy variable is also studied. Systems of vector autoregressions (VARs) for each of four countries -- the U.S., the U.K., Germany, and Japan -- are estimated, and the correlations among their residuals are studied. These represent the "innovations," or "news" in the time series. A clear pattern emerges in these correlations, in which policy in the U.S. and to a lesser extent Japan, drives exchange rates, and policy in Germany and the U.K. reacts. It appears that U.S. monetary policy is essentially determined by domestic considerations, with the exchange rate moving as a consequence. In Japan, interest rates are varied in response to movement in the current-account and relative price levels, and the effects on the exchange rate are partially neutralized by sterilized intervention. Germany and the U.K. react to movements in their exchange rates by moving interest rates, and sterilized intervention.

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    File URL: http://www.nber.org/papers/w0909.pdf
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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0909.

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    Date of creation: Jun 1982
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    Publication status: published as J. Bilson and R.C. Marston, editors. Exchange Rate Theory and Policy. Chicago: University of Chicago Press, 1984.
    Handle: RePEc:nbr:nberwo:0909

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    References

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    1. Jacques R. Artus, 1976. "Exchange Rate Stability and Managed Floating: The Experience of the Federal Republic of Germany (Stabilité du taux de change et flottement dirigé: l'expérience de l'Allemagne fédérale) ," IMF Staff Papers, Palgrave Macmillan, vol. 23(2), pages 312-333, July.
    2. Maurice Obstfeld, 1982. "Can We Sterilize? Theory and Evidence," NBER Working Papers 0833, National Bureau of Economic Research, Inc.
    3. Orley Ashenfelter & David Card, 1982. "Time Series Representation of Economic Variables and Alternative Models of the Labor Market," Working Papers 528, Princeton University, Department of Economics, Industrial Relations Section..
    4. Paul A. Anderson, 1979. "Help for the regional economic forecaster: vector autoregression," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum.
    5. William H. Branson, 1981. "Macroeconomic Determinants of Real Exchange Rates," NBER Working Papers 0801, National Bureau of Economic Research, Inc.
    6. Thomas J. Sargent, 1979. "Estimating vector autoregressions using methods not based on explicit economic theories," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum.
    7. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
    8. Marina V. N. Whitman, 1975. "Global Monetarism and the Monetary Approach to the Balance of Payments," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 6(3), pages 491-556.
    9. Branson, William H. & Halttunen, Hannu & Masson, Paul, 1977. "Exchange rates in the short run: The dollar-dentschemark rate," European Economic Review, Elsevier, vol. 10(3), pages 303-324.
    10. Taylor, John B., 1980. "Output and price stability: An international comparison," Journal of Economic Dynamics and Control, Elsevier, vol. 2(1), pages 109-132, May.
    11. Pentti J.K. Kouri, 1978. "Balance of Payments and the Foreign Exchange Market: A Dynamic Partial Equilibrium Model," Cowles Foundation Discussion Papers 510, Cowles Foundation for Research in Economics, Yale University.
    12. Rudiger Dornbusch, 1980. "Exchange Rate Economics: Where Do We Stand?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 11(1, Tenth ), pages 143-206.
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