Fiscal Policies and the Dollar/Pound Exchange Rate: 1870-1984

This paper investigates the consequences of fiscal policies for the exchange rate. After developing a simple theory of how government financing policies should effect the exchange rate, we test it using data on the dollar/pound exchange rate. Previous analyses have concentrated mainly on the past-Bretton Woods flexible exchange rate system, thus ignoring potentially useful information contained In fixed exchange rate periods or in previous flexible exchange rate periods. This paper shows that it is theoretically proper and econometrically feasible to merge evidence from different nominal exchange rate systems. The gain of this procedure is that we can extend the sample period back to the 1870's. Our results suggest that permanent government expenditures are the only fiscal variables that significantly affected the dollar/pound nominal exchange rate. Budget deficits appear to be irrelevant in this respect.

Liquidity Models in Open Economies: Theory and Empirical Evidence

This paper presents an overview of recent theoretical and empirical research on 'liquidity models' in open economies; this is a class of optimizing models where money has effects on real asset prices and economic activity without relying on the 'ad-hoc' assumption of price/wage stickiness. The non-neutrality of money derives from a temporary segmentation between goods and asset markets. After surveying the theoretical literature on liquidity models, we present empirical evidence based on VAR econometric techniques for the seven major industrial countries. Such evidence is shown to be consistent with the main implications of the liquidity models.

Financial Intermediation and Monetary Policies in the World Economy

In this paper we investigate the role of credit institutions in transmitting monetary shocks to the domestic economy and to the rest of the world output. In modeling the monetary and financial sector of the economy we distinguish between monetary injections via lump-sum transfers to individuals and those via increased credit to the commercial banking sector in the form of discount window operations. Appropriately, we distinguish between the discount rate of the central bank and the lending and borrowing interest rates of commercial banks, which, we assume, are also subject to reserves requirements. We find that a steady state increase in monetary injections via increases in domestic credit leads to an increase in domestic output. On the other hand, we find that an increase in the steady state level of monetary transfers reduces the level of output.

Endogenous Exchange Rate Regime Switches

In this paper we demonstrate that exchange rate regime switching is compatible with optimal government policies. Nominal exchange-rate regimes are formalized as equilibrium commitments on future seigniorage policies, and the collapse of an exchange-rate peg as an excusable default which allows the government to lump-sum tax private sector money holdings. We demonstrate that a regime in which the exchange-rate peg is allowed to collapse when government spending is unusually high is a trigger-strategy equilibrium. Such a regime can be superior to both fixed and flexible exchange rate because it combines some of the flexibility of the floating exchange rates with some of the benefits of precommitment afforded by fixed rates.

Bank Runs in Open Economies and The International Transmission of Panics

In this paper, we extend the bank run literature to an open economy model. We show that a foreign banking system, by raising deposit rates in the presence of a domestic banking panic, may generate sufficient liquid resources to acquire assets sold by the domestic banking system at bargain prices. In this case, foreign depositors will benefit from the domestic panic. We also show that our simple model is able to generate the spreading of panics. Perhaps not surprisingly, the crucial element in determining the propagation of financial crises is the effect of interest rates on savings decisions.

Managing Exchange Rate Crises: Evidence from the 1890's

This paper investigates the effectiveness of the monetary authority's borrowing policies in resolving exchange rate crises. It shows why obtaining loans or lines of credit in foreign currency may avoid, at least temporarily, the devaluation of a fixed exchange rate, and discusses the problem of the optimal size of the loan and/or the line of credit. The analysis focuses on a particular episode of foreign exchange rate pressure, during the troubled years between 1894 to 1896. The results suggest that the borrowing policy followed by the U.S. Treasury in those years was effective in avoiding the collapse of the United States' gold standard, and that the amount of the borrowing undertaken by the Treasury might have been optimal.