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Short-run independence of monetary policy under pegged exchange rates and effects of money on exchange rates and interest rates

  • Lee E. Ohanian
  • Alan C. Stockman

This paper examines the effects of money supply changes on exchange rates, interest rates, and production in an optimizing two-country model in which some sectors of the economy have predetermined nominal prices in the short run and other sectors have flexible prices. Money supply shocks have liquidity effects both within and across countries and induce a cross-country real-interest differential. The model predicts that liquidity effects are highly nonlinear and are not likely to be captured well empirically by linear models, particularly those involving only a single country. A striking implication of the model is that countries have a significant degree of short-run independence of monetary policy even under pegged exchange rates. Copyright 1997 by Ohio State University Press.

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Article provided by Federal Reserve Bank of Cleveland in its journal Proceedings.

Volume (Year): (1997)
Issue (Month): ()
Pages: 783-814

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Handle: RePEc:fip:fedcpr:y:1997:p:783-814
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  1. Cumby, Robert E. & Huizinga, John, 1991. "The predictability of real exchange rate changes in the short and long run," Japan and the World Economy, Elsevier, vol. 3(1), pages 17-38, April.
  2. Svensson, Lars E O & van Wijnbergen, Sweder, 1989. "Excess Capacity, Monopolistic Competition, and International Transmission of Monetary Disturbances," Economic Journal, Royal Economic Society, vol. 99(397), pages 785-805, September.
  3. Alan C. Stockman, 1978. "A Theory of Exchange Rate Determination," UCLA Economics Working Papers 122, UCLA Department of Economics.
  4. Charles Engel, 1991. "Is real exchange rate variability caused by relative price changes? An empirical investigation," Research Working Paper 91-02, Federal Reserve Bank of Kansas City.
  5. Mussa, Michael, 1982. "A Model of Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 74-104, February.
  6. Ben S. Bernanke & Alan S. Blinder, 1989. "The federal funds rate and the channels of monetary transmission," Working Papers 89-10, Federal Reserve Bank of Philadelphia.
  7. Stockman, Alan C. & Stockman, Alan C., 1983. "Real exchange rates under alternative nominal exchange-rate systems," Journal of International Money and Finance, Elsevier, vol. 2(2), pages 147-166, August.
  8. Rotemberg, Julio J, 1984. "A Monetary Equilibrium Model with Transactions Costs," Journal of Political Economy, University of Chicago Press, vol. 92(1), pages 40-58, February.
  9. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
  10. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  11. Huizinga, John, 1987. "An empirical investigation of the long-run behavior of real exchange rates," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 27(1), pages 149-214, January.
  12. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, vol. 77(4), pages 647-66, September.
  13. Alan C. Stockman, 1988. "Real Exchange Rate Variability under Pegged and Floating Nominal Exchange Rate Systems: An Equilibrium Theory," NBER Working Papers 2565, National Bureau of Economic Research, Inc.
  14. Svensson, Lars E O, 1986. "Sticky Goods Prices, Flexible Asset Prices, Monopolistic Competition, and Monetary Policy," Review of Economic Studies, Wiley Blackwell, vol. 53(3), pages 385-405, July.
  15. Grossman, Sanford & Weiss, Laurence, 1983. "A Transactions-Based Model of the Monetary Transmission Mechanism," American Economic Review, American Economic Association, vol. 73(5), pages 871-80, December.
  16. 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.
  17. Alan C. Stockman, 1992. "International Transmission Under Bretton Woods," NBER Working Papers 4127, National Bureau of Economic Research, Inc.
  18. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
  19. Lucas, Robert Jr., 1990. "Liquidity and interest rates," Journal of Economic Theory, Elsevier, vol. 50(2), pages 237-264, April.
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