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Exchange-Rate Policy After a Decade of "Floating"

  • William H. Branson
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    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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    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
    Note: ITI IFM
    Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
    Phone: 617-868-3900
    Web page: http://www.nber.org
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    1. 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.
    2. William H. Branson, 1981. "Macroeconomic Determinants of Real Exchange Rates," NBER Working Papers 0801, National Bureau of Economic Research, Inc.
    3. 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.
    4. 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.
    5. Paul A. Anderson, 1979. "Help for the regional economic forecaster: vector autoregression," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum.
    6. 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.
    7. 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.
    8. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
    9. 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) (La estabi," IMF Staff Papers, Palgrave Macmillan, vol. 23(2), pages 312-333, July.
    10. Obstfeld, Maurice, 1982. "Can We Sterilize? Theory and Evidence," American Economic Review, American Economic Association, vol. 72(2), pages 45-50, May.
    11. Ashenfelter, Orley C & Card, David, 1982. "Time Series Representations of Economic Variables and Alternative Models of the Labour Market," Review of Economic Studies, Wiley Blackwell, vol. 49(5), pages 761-81, Special I.
    12. Thomas J. Sargent, 1979. "Estimating vector autoregressions using methods not based on explicit economic theories," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum.
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