Monetary Policy: Domestic Targets and International Constraints

This paper argues that macroeconomic policies for open economies differ, in fundamentally important ways, from the corresponding policies for closed economies.The openness of the economy imposes constraints on the effectiveness and proper conduct of macroeconomic policies and it also provides policy makers with infor-mation which may be usefully exploited in the design of policy. The discussion in this paper focuses on the dependence of monetary policy on the constraints and the information that are provided by the external sector. Section I summarizes briefly the characteristics of the international constraints on monetary policy.Section II deals with intervention in the foreign-exchange market and its relation to monetary policy. In this context the distinction between sterilized and non-sterilized interventions is drawn and the implications of the various forms of intarventions for the effectiveness of monetary policy are examined. Finally,Section III addresses the question of the role that exchange rates should play in the design of monetary policy. It is argued that data from the market for foreign exchange in combination with data on interest rates can provide the monetary authorities with useful information on money market conditions and thereby can contribute to the improved conduct of monetary policy.

Further Evidence On Expectations And The Demand for Money During the German Hyperinflation

Probably no event in monetary history has been more studied than the German hyperinflation of the early 1920's. Economists have been attracted to study this episode since it provides an environment that is close to a controlled experiment which is so rare in the study of social sciences. This paper provides further evidence on the role of expectations in effecting the demand for money during the German hyperinflation. One of the difficulties in studying empirically the role of expectations is the lack of an observable variable measuring expectations. This paper examines three measures of expectations that are derived from observed data from the market for foreign exchange. The first measure is based on the hypothesis that the forward exchange rate measures the expected future spot exchange rate and thereby provides an observable measure of the market's expectations concerning the depreciation of the currency. The other two measures distinguish between the forward exchange rate and the expected exchange rate and are based on the supplementary hypothesis that rational behavior requires expectations to be unbiased. Accordingly, the measures of expectations are constructed by using the forward exchange rate along with the information on the systematic relationship between forward and spot exchange rates. The various measures are then used in estimating the demand for money. The emphasis on measures of expectations that are based on data from the foreign exchange markets reflects the belief that in an inflationary economy with flexible exchange rates one of the relevant substitutes for holding domestic money is foreign exchange.

Exchange Rates, Prices and Money: Lessons from the 1920s

This paper summarizes the results of an empirical study of the operation of flexible exchange rates during the 1920's under both the hyperinflationary conditions (based on the experience of Germany) and under the normal conditions (based on the experience of Britain, the United States and France).Section I deals with some general characteristics of the market for foreign exchange by examining the relationship between spot and forward exchange rates. Section II deals with the relationship between exchange rates and prices by examining aspects of the purchasing power parity doctrine. Section III deals with the determinants of exchange rates within the context of a simple monetary model.

The Collapse of Purchasing Power Parities during the 1970s

This paper reviews and analyzes the empirical record of exchange rates and prices during the 1970's and the analysis is based on the experience of the Dollar/Pound, the Dollar/French Franc and the Dollar/DM exchange rates. Section 2 presents the evidence on PPP during the 1970's and contrasts it with the evidence from the 1920's -- a period during which the doctrine held up reasonably well. This analysis is relevant for assessing whether the flexible exchange rate system was successful in providing national economies with an added degree of insulation from foreign shocks, and whether it provided policymakers with an added instrument for the conduct of macroeconomic policy. The evidence regarding deviations from purchasing power parities is also relevant for determining whether there is a case for managed float. Section 3 attempts to explain what went wrong with the performance of the doctrine during the 1970's. It examines the hypothesis that the departures from PPP are a U.S. phenomenon, as well as the hypothesis that the departures are due to large changes in inter-sectoral relative price changes within the various economies. Given that the predictions of the simple versions of PPP do not hold up, section 4 proceeds in examining the question of whether national price levels have been independent of each other. Section 5 addresses the question of whether exchange rates and national price levels are comparable and whether in principle one should have expected them to be closely linked to each other. The main point that is being emphasized is that there is an important intrinsic difference between exchange rates and national price levels which stems from the basset market theory' of exchange rate determination. This theory implies that the exchange rate, like the prices of other assets, is much more sensitive to expectations concerning future events than national price levels and as a result, in periods which are dominated by news' which alter expectations, exchange rates are likely to be much more volatile than national price levels and departures from PPP are likely to be the rule rather than the exception. Finally, section 6 concludes the paper with some policy implications.

The coordination of economic policies

Foreign exchange rates

Commentary : global demographic change : economic impacts and policy challenges

Population ; Economic conditions

International Reserves Under Alternative Exchange Rate Regimes and Aspects of The Economics of Managed Float

This paper contains an analysis of the role of international reserves under a regime of pegged exchange rates and under a regime of managed floating. It presents evidence on the stability of the demand for reserves during the periods 1963-72 and 1973-75. It is shown that the demand for reserves by developed countries differs from that of less-developed countries and that the system underwent a structural change by the end of 1972. In view of the drastic change in the international monetary system, the extent of the structural change has not been as large as might have been expected, thus leading to the observation that economic behavior seems to be more stable than legal arrangements. From the policy perspective it follows that the problems concerning the role of the International Monetary Fund in this context are as relevant at the present as they were in the past. The paper concludes with a sketch of a stochastic framework for the analysis of the optimal degree of managed floating. And its purpose is to suggest an additional set of variables which might be incorporated into the specification of the demand for international reserves. It is shown that the optimal degree of exchange rate flexibility depends on the stochastic nature of the shocks that the economy faces. The stochastic characteristics of the shocks include a distinction between real and monetary shocks, domestic and foreign shocks and depend on the covariances among the various shocks.