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Can Using Interest Rates to Check Domestic Demand Raise the Strength of the Sterling in the Long Run?

  • Eleni Iliopulos

    ()

    (University of Pavia and EPEE, University of Evry)

  • Marcus Miller

    (University of Warwick and CEPR)

An updated version of Krugman’s (1993) MMF framework is used to consider the implications of buoyant domestic demand for the real exchange rate and debt dynamics. The updating includes a Taylor rule for monetary policy and explicit treatment of external assets and liabilities. In response to an exogenous rise in the aggregate demand, short-run appreciation of the real exchange rate is followed by a prolonged decline as external debt accumulates and net wealth dete- riorates. Whether in equilibrium the real exchange rate is stronger or weaker depends crucially on a comparison of real interest rates and the growth rate. If the domestic growth rate is higher than global real interest rates, the currency may strengthen in the long run despite the deterioration of net external assets. To see whether the strength of sterling is sustainable, the analysis is brie‡y calibrated to UK data over the last decade. Blanchard, Giavazzi and Sa (2005) suggest that international liabilities to be treated as imperfect substitutes: so we check to see how this would affect our results.

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File URL: http://epee.univ-evry.fr/RePEc/2006/06-13.pdf
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Paper provided by Centre d'Études des Politiques Économiques (EPEE), Université d'Evry Val d'Essonne in its series Documents de recherche with number 06-13.

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Length: 28 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:eve:wpaper:06-13
Contact details of provider: Postal: 4, bld Francois Mitterand, 91025 Evry Cedex
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Web page: http://epee.univ-evry.fr

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  1. Wynne Godley & Alex Izurieta & Gennaro Zezza, 2004. "Prospects and Policies for the U.S. Economy: Why Net Exports Must Now Be the Motor for U.S. Growth," Economics Strategic Analysis Archive 04-7, Levy Economics Institute.
  2. repec:tcd:wpaper:tep16 is not listed on IDEAS
  3. Philip R. Lane & Gian Maria Milesi-Ferretti, 2005. "A Global Perspective on External Positions," NBER Working Papers 11589, National Bureau of Economic Research, Inc.
  4. Olivier Blanchard & Francesco Giavazzi & Filipa Sa, 2005. "The U.S. Current Account and the Dollar," NBER Working Papers 11137, National Bureau of Economic Research, Inc.
  5. Ricardo Hausmann and Federico Sturzenegger, 2006. "Global imbalances or bad accounting? The missing dark matter in the wealth of nations," Business School Working Papers globalimbal, Universidad Torcuato Di Tella.
  6. Barry Eichengreen & Ricardo Hausmann & Ugo Panizza, 2003. "Currency Mismatches, Debt Intolerance and Original Sin: Why They Are Not the Same and Why it Matters," NBER Working Papers 10036, National Bureau of Economic Research, Inc.
  7. Leith, Campbell & Wren-Lewis, Simon, 2008. "Interactions between monetary and fiscal policy under flexible exchange rates," Journal of Economic Dynamics and Control, Elsevier, vol. 32(9), pages 2854-2882, September.
  8. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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