Stochastic Monetary Interdependence, Currency Regime Choice and the Operation of Monetary Policy
AbstractA theory is developed to explain a number of stylized facts well known to international economists: first, countries' real and nominal exchange rates tend to move together under flexible exchange rate systems with the ratios of domestic to rest-of-world price levels showing much less variability; and second, business cycles and medium-term price level movements tend to be international in scope; third, forward exchange rates track the corresponding spot rates very well but show much less variability than spot rates, with forward discounts performing poorly as predictors of subsequent changes in spot rates. It ascribes these phenomena to the maximizing behavior of central banks, each pursuing similar objectives, in a world where information about the future course of economic activity and the timing of the influence of central bank policy upon it is extremely poor. It shows how central banks, given the limited information available to them, are induced to set a path of monetary growth that will neutralize the effects of international portfolio shocks on the exchange rate, while allowing movements in exchange rates that result from changes in technology, oil shocks, the terms of trade and other real forces to go through unopposed. The result is a similarity of credit conditions across countries leading to world-wide variations of outputs and inflation rates. In addition to explaining the conditions under which countries will chose flexible exchange rates rather than fixed rates, the analysis yields important insights for evaluating and extending recent work on the transmission of monetary shocks to economic activity.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by University of Toronto, Department of Economics in its series Working Papers with number floyd-98-01.
Length: 43 pages
Date of creation: 28 Jul 1998
Date of revision:
Contact details of provider:
Postal: 150 St. George Street, Toronto, Ontario
Phone: (416) 978-5283
Find related papers by JEL classification:
- F3 - International Economics - - International Finance
- E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
- F1 - International Economics - - Trade
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-06-07 (All new papers)
- NEP-IFN-2004-06-07 (International Finance)
- NEP-MON-2004-06-07 (Monetary Economics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1998.
"Monetary Policy Shocks: What Have We Learned and to What End?,"
NBER Working Papers
6400, National Bureau of Economic Research, Inc.
- Christiano, Lawrence J. & Eichenbaum, Martin & Evans, Charles L., 1999. "Monetary policy shocks: What have we learned and to what end?," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 2, pages 65-148 Elsevier.
- Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 1997. "Monetary policy shocks: what have we learned and to what end?," Working Paper Series, Macroeconomic Issues WP-97-18, Federal Reserve Bank of Chicago.
- Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
- William Poole, 1969.
"Optimal choice of monetary policy instruments in a simple stochastic macro model,"
Special Studies Papers
2, Board of Governors of the Federal Reserve System (U.S.).
- Poole, William, 1970. "Optimal Choice of Monetary Policy Instruments in a Simple Stochastic Macro Model," The Quarterly Journal of Economics, MIT Press, vol. 84(2), pages 197-216, May.
- William Poole, 1970. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Staff Studies 57, Board of Governors of the Federal Reserve System (U.S.).
- Baxter, Marianne & Stockman, Alan C., 1989. "Business cycles and the exchange-rate regime : Some international evidence," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 377-400, May.
- Mussa, Michael, 1979. "Empirical regularities in the behavior of exchange rates and theories of the foreign exchange market," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 11(1), pages 9-57, January.
- Bennett T. McCallum, 1994.
"A Reconsideration of the Uncovered Interest Parity Relationship,"
NBER Working Papers
4113, National Bureau of Economic Research, Inc.
- McCallum, Bennett T., 1994. "A reconsideration of the uncovered interest parity relationship," Journal of Monetary Economics, Elsevier, vol. 33(1), pages 105-132, February.
- Richard H. Clarida & Mark Gertler, 1997.
"How the Bundesbank Conducts Monetary Policy,"
in: Reducing Inflation: Motivation and Strategy, pages 363-412
National Bureau of Economic Research, Inc.
- Richard Clarida & Mark Gertler, 1996. "How the Bundesbank Conducts Monetary Policy," NBER Working Papers 5581, National Bureau of Economic Research, Inc.
- Clarida, R. & Gertler, M., 1996. "How the Bundesbank Conducts Monetary Policy," Working Papers 96-14, C.V. Starr Center for Applied Economics, New York University.
- Sims, Christopher A., 1992.
"Interpreting the macroeconomic time series facts : The effects of monetary policy,"
European Economic Review,
Elsevier, vol. 36(5), pages 975-1000, June.
- Christopher A. Sims, 1992. "Interpreting the Macroeconomic Time Series Facts: The Effects of Monetary Policy," Cowles Foundation Discussion Papers 1011, Cowles Foundation for Research in Economics, Yale University.
- Turnovsky, Stephen J, 1976. "The Relative Stability of Alternative Exchange Rate Systems in the Presence of Random Disturbances," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 8(1), pages 29-50, February.
- John B. Taylor, 1995.
"The Monetary Transmission Mechanism: An Empirical Framework,"
Journal of Economic Perspectives,
American Economic Association, vol. 9(4), pages 11-26, Fall.
- John B. Taylor, 1995. "The monetary transmission mechanism: an empirical framework," Working Papers in Applied Economic Theory 95-07, Federal Reserve Bank of San Francisco.
- Gilles Oudiz & Jeffrey Sachs, 1984. "Macroeconomic Policy Coordination among the Industrial Economies," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(1), pages 1-76.
- David K. Backus & Patrick J. Kehoe & Finn E. Kydland, 1987.
"International real business cycles,"
426, Federal Reserve Bank of Minneapolis.
- Matthew B. Canzoneri & Dale W. Henderson, 1991. "Monetary Policy in Interdependent Economies: A Game-Theoretic Approach," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262031787, January.
- Boyer, Russell S, 1978. "Optimal Foreign Exchange Market Intervention," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 1045-55, December.
- David B. Gordon & Eric M. Leeper, 1992.
"The dynamic impacts of monetary policy: an exercise in tentative identification,"
92-13, Federal Reserve Bank of Atlanta.
- Gordon, David B & Leeper, Eric M, 1994. "The Dynamic Impacts of Monetary Policy: An Exercise in Tentative Identification," Journal of Political Economy, University of Chicago Press, vol. 102(6), pages 1228-47, December.
- David B. Gordon & Eric M. Leeper, 1993. "The dynamic impacts of monetary policy: an exercise in tentative identification," Working Paper 93-5, Federal Reserve Bank of Atlanta.
- Eric M. Leeper & Christopher A. Sims & Tao Zha, 1996. "What Does Monetary Policy Do?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(2), pages 1-78.
- Laubach, T. & Posen, A.S., 1997. "Disciplined Discretion: Monetary Targeting in Germany and Switzerland," Princeton Essays in International Economics 206, International Economics Section, Departement of Economics Princeton University,.
- Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
- John E. Floyd, 1998. "Monetary Policy and the Real Exchange Rate: Some Evidence," Working Papers floyd-98-02, University of Toronto, Department of Economics.
- Weber, Warren E, 1981. "Output Variability under Monetary Policy and Exchange Rate Rules," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 733-51, August.
- Lucas, Robert E, Jr, 1973. "Some International Evidence on Output-Inflation Tradeoffs," American Economic Review, American Economic Association, vol. 63(3), pages 326-34, June.
- Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (RePEc Maintainer).
If references are entirely missing, you can add them using this form.