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Real effects of monetary policy in a world economy

  • Preston J. Miller
  • Richard M. Todd
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    We present a 2-country model with heterogeneous agents in which changes in a country’s monetary policy affect real interest rates, relative prices of traded and nontraded goods and real exchange rates. Nontransitory real effects of monetary policy stem solely from a friction (country-specific reserve requirements) that generates separate demands for a country’s money and bonds. Without violating the classical assumptions of individual rationality and flexible prices, the model’s implications seem qualitatively in accord with the U.S. experience of the 1980s: a monetary policy tightening leading to a rise in the real interest rate and to an initial rise in the real value of the dollar which is subsequently reversed. In the model a monetary policy change leads to different welfare effects for agents born at different times, living in different countries, or participating on different sides of a market. The welfare of some agents can be affected more by relative price changes than by real interest rate changes.

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    Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 154.

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    Date of creation: 1992
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    Handle: RePEc:fip:fedmsr:154
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    1. Julio J. Rotemberg, 1982. "Money and the Terms of Trade," NBER Working Papers 1003, National Bureau of Economic Research, Inc.
    2. R. Dornbusch, 1975. "Exchange Rate Dynamics," Working papers 167, Massachusetts Institute of Technology (MIT), Department of Economics.
    3. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
    4. Blanchard, Olivier J, 1984. "The Lucas Critique and the Volcker Deflation," American Economic Review, American Economic Association, vol. 74(2), pages 211-15, May.
    5. Miller, Preston J & Roberds, William T, 1991. "The Quantitative Significance of the Lucas Critique: Reply," Journal of Business & Economic Statistics, American Statistical Association, vol. 9(4), pages 389, October.
    6. Michael J. Stutzer, 1985. "The statewide economic impact of small-issue industrial revenue bonds," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Spr.
    7. Frenkel, Jacob A & Razin, Assaf, 1986. "Fiscal Policies in the World Economy," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 564-94, June.
    8. Aizenman, Joshua, 1983. "A theory of current account and exchange rate determinations," European Economic Review, Elsevier, vol. 23(3), pages 261-280, September.
    9. Ayse Imrohoroglu & Edward C. Prescott, 1991. "Evaluating the welfare effects of alternative monetary arrangements," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 3-10.
    10. Preston J. Miller & William Roberds, 1987. "The quantitative significance of the Lucas critique," Staff Report 109, Federal Reserve Bank of Minneapolis.
    11. Jeremy Greenwood, 1984. "Non-traded Goods, the Trade Balance, and the Balance of Payments," Canadian Journal of Economics, Canadian Economics Association, vol. 17(4), pages 806-23, November.
    12. Preston J. Miller & Neil Wallace, 1985. "International coordination of macroeconomic policies: a welfare analysis," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Spr.
    13. Orden, David, 2002. "Exchange Rate Effects On Agricultural Trade," Journal of Agricultural and Applied Economics, Southern Agricultural Economics Association, vol. 34(02), August.
    14. Preston J. Miller, 1982. "Fiscal policy in a monetarist model," Staff Report 67, Federal Reserve Bank of Minneapolis.
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