Wolff, Christian C.P.

English

Research Papers in Economics

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Review: [untitled]
Author(s): Christian C. P. Wolff
Reviewed work(s): Exchange Rate Economics. by Peter Isard
Source: Journal of Economic Literature, Vol. 35, No. 2, (Jun., 1997), pp. 784-786
Published by: American Economic Association
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premise  throughout  is  that  cooperation  is 
clearly a good idea but that the  benefits  of 
coordination  of  policies  are  ambiguous  al- 
though likely to be beneficial. 
The core analytical treatment is contained 
in Chapters 3 through 5. These chapters pre- 
sent the insights from the literature on policy 
optimization (Ch. 3), the literature on policy 
rules  (Ch. 4),  and the  institutionalist litera- 
ture  (Ch. 5)  under the  assumption that the 
role of government cooperation is to correct 
some form of market failure. Chapter 6 then 
points out the possibility of government fail- 
ure rather than market failure and explores 
whether in this case  coordination can make 
things  worse  rather  than  better.  Bryant 
acknowledges the  possibility  that  coordina- 
tion can be  counterproductive but is clearly 
optimistic that the  gains from coordination 
outweigh the possible costs. 
In  Chapter 7  the  author shifts  his  focus 
from the theoretical desirability or otherwise 
of cooperation to asking what is feasible from 
a  practical perspective,  given  that  the  real 
world may be  more complex and uncertain 
than assumed in the  analytical literature. It 
becomes clear in this chapter that Bryant be- 
lieves cooperation between governments and 
greater coordination of  policies  on  a  more 
structured and regular basis are good ideas. 
In Chapter 8 he departs from the analytical 
approach and presents  some  empirical evi- 
dence  on  the  interdependence  between 
economies  from  the  leading  multi-country 
models. Unfortunately this chapter is not as 
extensive as I would have preferred given the 
advances in  multi-country modeling  of  the 
last  decade  (which Bryant has  documented 
elsewhere). It would have been helpful in this 
chapter to  have a summary table  of  results 
from a range of models to illustrate the mag- 
nitudes  (and  signs)  of  spillovers  between 
economies as currently estimated rather than 
the more analytical presentation contained in 
Chapter 8.  This  would  help  the  reader to 
understand the  extent  of  interdependence. 
Nonetheless  this  information is  available in 
the  documents  referenced  throughout  the 
chapter. 
Chapter 9 looks back at the postwar histori- 
cal record of cooperation. This is a clear and 
very useful summary  of the experience at pol- 
icy cooperation in the postwar period. There 
are also some important lessons drawn from 
the historical experience. In particular, Bry- 
ant argues that the types of shocks that policy 
makers have faced have varied considerably 
and only in extreme crises does cooperation 
occur. He also argues that there is no appar- 
ent trend increase in cooperation despite the 
greater  interdependence  of  economies.  I 
agree with  many of  Bryant's policy  conclu- 
sions in Chapter 9, in particular that the key 
to the future of cooperation (and indeed the 
key  to  improving  macroeconomic  policy 
whether cooperative or noncooperative) is in 
developing the analytical frameworks  for pol- 
icy  makers. This analytical support includes 
more  extensive  collection  of  better  data as 
well as increased funding of research on eco- 
nomic interdependence. 
In sum, this book is a valuable contribution 
to the policy debate on coordinating macro- 
economic policies between economies. A par- 
ticularly useful aspect of the study is the in- 
clusion of critical comments by two leading 
researchers ,  Paul Masson and Takatoshi Ito. 
These  comments  provide  the  reader  with 
some critical assessment of Ralph Bryant's  ar- 
guments and complement  a very thoughtful 
book. I highly recommend this timely volume 
as  essential  reading for  policy  makers and 
scholars interested in the issue of coordinat- 
ing macroeconomic policies in an increasingly 
interdependent global economy. 
WARWICK  MCKIBBIN 
Australian  National  University 
Exchange  rate economics.  By PETER ISARD. Sur- 
veys  of  Economic  Literature. Cambridge; 
New York and Melbourne:  Cambridge  Uni- 
versity  Press, 1995. Pp. xvi, 275. $59.95, cloth; 
$18.95, paper. ISBN 0-521-46047-6,  cloth; 
0-521-46600-8, pbk.  JEL 96-0548 
This  interesting volume  provides a  fairly 
comprehensive  overview of  advances in  ex- 
change  rate  economics  in  the  two  decades 
prior to  its  publication. It  is very readable, 
relatively nontechnical, and of potential inter- 
est  to  students,  research  economists,  and 
policy  makers. Its  coverage is  quite  broad, 
ranging from institutional and historical per- 
spectives to theoretical and empirical models 
of  exchange rate behavior, and to policy is- Book Reviews  785 
sues. The volume is organized in three parts. 
Part I covers historical and institutional per- 
spectives, Part II covers models of exchange 
rate behavior, and  Part III  focuses  on  ex- 
change rate policies. 
After a brief introductory chapter, Chapter 
2,  entitled  "Foreign Exchange Markets and 
the Marketability  of Money," traces the roots 
of money and exchange rates and provides a 
description of the  modern foreign exchange 
market. Chapter 3, "Exchange Rate Arrange- 
ments and International Monetary Regimes" 
provides a detailed account of monetary re- 
gimes  and exchange rate mechanisms since 
the  eighteenth  century. Special attention is 
paid  to  the  international gold  standard re- 
gime, the wartime and interwar regimes, the 
Bretton Woods  system,  and the  subsequent 
floating rate period. 
Part II  is  the  core  of  the  book in which 
models  of  exchange  rate  behavior are  dis- 
cussed in detail. Chapter 4, "Exchange Rates 
and National Price Levels," provides an over- 
view of the purchasing power parity hypothe- 
sis,  arguments against the  hypothesis,  and 
relevant  empirical  evidence.  It  concludes 
with some interesting observations on norma- 
tive applications of Purchasing Power Parity. 
Chapter  5,  "Exchange Rates  and  Interest 
Rates," provides a fairly standard discussion 
of covered and uncovered interest parity, in- 
cluding a short, partial overview of empirical 
results from survey data. 
In  Chapter 6,  "Exchange Rates  and  the 
Balance of  Payments," the  author first pre- 
sents  the  traditional elasticities  approach to 
the balance of payments and continues with 
the  familiar Mundell-Fleming framework to 
analyze stabilization policy in an open econ- 
omy.  In  the  latter part of  the  chapter the 
monetary and portfolio balance approaches to 
the balance of payments are outlined. Chap- 
ter 7, "News, Revisions in Expectations, and 
Exchange  Rate  Dynamics," gives  a  concise 
but precise overview of the Dornbusch "over- 
shooting" model  before  turning the  "news" 
approach  to  exchange  rate  determination. 
The  latter  approach receives  limited  atten- 
tion.  The  chapter closes  with  a brief,  non- 
technical discussion of Krugman's  target zone 
model and related empirical evidence. Chap- 
ter  8  is  entitled  "Empirical Estimates  of 
Structural Exchange Rate Models." Here the 
author  discusses  in-sample  estimates  of 
monetary models  (of both the  flexible-price 
and sticky-price varieties) and portfolio bal- 
ance models of the exchange rate. Then, at- 
tention is paid to the Meese and Rogoff out- 
of-sample  results  and  related  studies.  The 
chapter closes with a brief discussion of the 
(de)merits  of  large-scale  macroeconometric 
models. 
The most interesting parts of the book, to 
my taste, are Chapters 9 and 10, which con- 
clude Part II. Chapter 9, "New Perspectives 
from  Optimizing  Models  of  Realignments 
Under Fixed Exchange Rates," discusses re- 
cent approaches to modeling macroeconomic 
behavior under fixed exchange rates. Here, 
the  timing and magnitude of  exchange rate 
realignments are treated as solutions to  ex- 
plicit policy optimization problems. Specula- 
tive attacks and realignment expectations play 
an important role in this chapter. The author 
provides  an  interesting  example,  borrowed 
from one  of  his  own recent  articles, of  the 
conceptual framework. The  example is  ana- 
lyzed  in  detail  and  policy  implications  are 
explored. Chapter 10 is called "New Direc- 
tions for Conceptual Models of Flexible Ex- 
change  Rates" and focuses  on  information. 
Two  types  of  models  are distinguished: (1) 
models with  rational expectations and com- 
plete  information and (2)  models with irra- 
tionality or limited information. In the  con- 
text  of  the  former type,  the  author focuses 
mainly  on  real  intertemporal  equilibrium 
models. He concludes the chapter with an in- 
teresting and balanced discussion of the use- 
fulness  of  models with rational expectations 
and complete information. 
Part III addresses exchange rate policies. It 
is  organized  in  two  chapters.  Chapter  11, 
"The  Choice  of  Exchange  Rate  Arrange- 
ments," gives a broad overview of arguments 
that are relevant to the issue of optimum cur- 
rency areas. Subsequently, the  evolution  of 
European exchange rate arrangements  is out- 
lined. The latter part of the chapter offers a 
good  discussion of  the  merits of  hybrid ex- 
change rate arrangements (flexible, but man- 
aged,  or  fixed,  but  adjustable,  systems). 
Chapter 12  is  on  "Policy-oriented Perspec- 
tives  on  Exchange  Rate  Stability" and  dis- 786  Journal of Economic Literature,  Vol. XXXV (June 1997) 
cusses a number of recent policy issues: capi- 
tal controls, the capital inflows problem and 
international policy cooperation. The discus- 
sion  is  informed and interesting.  The  book 
closes with the observation that 
the prospects  for achieving  greater  stability  of 
key currency exchange rates in  the  years 
ahead  cannot  be much  enhanced  by changing 
the nature  of exchange  rate  arrangements  per 
se. Such prospects,  rather  depend largely  on 
improving the  quality of  national macro- 
economic  policies  and  international  policy  co- 
operation,  which  in turn depends  both on in- 
creasing the effectiveness of policy analysis 
and on overcoming  political impediments  to 
the timely adoption  of appropriate  policies. 
(pp. 235-36) 
Peter Isard  has written  an interesting  and useful 
book. I particularly  admired  his presentation  of 
new approaches  to exchange  rate  modeling. 
CHRISTIAN  C. P. WOLFF 
Maastricht  University 
Economic  and monetary  union in Europe:  Mov- 
ing beyond Maastricht. By PETER  B. KENEN. 
Cambridge;  New York  and Melbourne:  Cam- 
bridge University Press, 1995. Pp. ix, 219. 
$49.95, cloth; $16.95, paper. ISBN  0-521- 
47079-X, cloth;  0-521-55883-2, pbk. 
JEL 96-0969 
The  Treaty on  European Union  of  1993, 
also known as the Maastricht Treaty, will be 
remembered  as  having  set  precise  criteria 
and deadlines for the  creation of  economic 
and  monetary union  (EMU).  While  at  the 
time  of  writing we  do  not  know the  exact 
shape  of  EMU,  there  is  much  less  doubt 
about its very existence.  It is a bold experi- 
ment for it attempts the  creation of a large 
monetary union before political unification, a 
rare historical fact. Peter Kenen's monograph 
is  a penetrating account of  EMU's  antece- 
dents,  possible  configurations, and implica- 
tions. Not only it is a welcome monograph for 
specialists in monetary integration, but it also 
has pedagogical merit for upper undergradu- 
ate  and master's level  classes in  economics 
and political science. 
There  are  eight  chapters in  the  volume. 
Chapter 1 reviews the  essential antecedents 
of EMU, starting with the Werner Report of 
1970 and ending with the  Delors  Report of 
1989. While the underlying economic and po- 
litical premises  differ significantly, both  re- 
ports  envision  a  three-stage  approach  to 
EMU,  complete  capital integration  and  ir- 
revocable  locking  of  Community  exchange 
rates. The  Delors  Report found its way, al- 
most  entirely,  into  the  Maastricht Treaty. 
Chapter  2  describes  the  design  of  EMU. 
What emerged  in the  Maastricht Treaty re- 
flects German preferences: economic conver- 
gence  as a precondition for monetary union, 
commitment to price stability, and indepen- 
dence  of the future European Central Bank 
(ECB). Germany, after all, with the lowest in- 
flation rate and the most independent central 
bank in  the  Community, had  more  to  lose 
from  EMU  than  other  member  countries. 
Despite  the  seemingly ironclad commitment 
to price stability, the Treaty leaves the door 
open  for  the  politicians  to  determine  ex- 
change-rate  agreements  with  outside  coun- 
tries and, thus, create a potential conflict with 
price stability. Kenen reckons that this con- 
flict is of minor concern. Yet, the French in- 
sist on its importance in order to create a po- 
litical counterweight to the independence of 
the European Central Bank. 
Chapter 3 is the  most innovative essay of 
the book: it deals with possible configurations 
of EMU in the third and final stage. There, 
three different models of open-market opera- 
tions  are analyzed: (i)  a  centralized system 
where all bids are placed at the  ECB; (ii) a 
distributive approach in which the ECB sets 
the  size and terms of the  operation and the 
national central banks (NCBs) would conduct 
their tenders based on their quotas; (iii) a de- 
centralized approach with NCBs conducting 
their own tenders but constrained by a range 
determined by the  ECB.  The  decentralized 
model would create unnecessary noise. Each 
NCB may set different terms for the tender, 
encouraging arbitrage activity to eliminate in- 
terest  rate  differentials. So  the  choice  falls 
between  either of the first two options. But, 
as  Kenen  argues  correctly,  the  centralized 
model  would  not  receive  much  sympathy 
from the national governors in the Governing 
Council of the ECB. 
Chapter  4  deals  with  fiscal  policy  in  a 
monetary union. The latter implies that EMU 
countries can no longer rely on independent 
monetary policies.  Hence,  the  case  for na- 

Exchange rate economics / Peter Isard.

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Exchange rate economics / Peter Isard.

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