The Monetary Approach: Flexible Exchange Rates · Outline Key Ingredients of the Monetary Approach...
Transcript of The Monetary Approach: Flexible Exchange Rates · Outline Key Ingredients of the Monetary Approach...
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
The Monetary Approach:Flexible Exchange Rates
Alan G. Isaac
January 21, 2010
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Outline
Key Ingredients of the Monetary ApproachExogenous Real Exchange RatesThe Classical Model of Price Determination
The Crude Monetary Approach Model
Exchange Rates and Anticipated Monetary Policy
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Exogenous Real Exchange RatesThe Classical Model of Price Determination
Monetary Approach: Key Ingredients
I exogenous real exchange rate
Qdef=
SP∗
P=⇒ S = Q
P
P∗
I Classical model of PI stable money demand: L(i ,Y )I H/P = L(i ,Y ) continuouslyI exogenous: Y , r , and HI P (not i) clears money market
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Exogenous Real Exchange RatesThe Classical Model of Price Determination
Monetary Approach: Key Ingredients
I exogenous real exchange rate
Qdef=
SP∗
P=⇒ S = Q
P
P∗
I Classical model of PI stable money demand: L(i ,Y )I H/P = L(i ,Y ) continuouslyI exogenous: Y , r , and HI P (not i) clears money market
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Exogenous Real Exchange RatesThe Classical Model of Price Determination
Monetary Approach: Key Ingredients
I exogenous real exchange rate
Qdef=
SP∗
P=⇒ S = Q
P
P∗
I Classical model of PI stable money demand: L(i ,Y )I H/P = L(i ,Y ) continuouslyI exogenous: Y , r , and HI P (not i) clears money market
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Exogenous Real Exchange RatesThe Classical Model of Price Determination
Monetary Approach: Key Ingredients
I exogenous real exchange rate
Qdef=
SP∗
P=⇒ S = Q
P
P∗
I Classical model of PI stable money demand: L(i ,Y )I H/P = L(i ,Y ) continuouslyI exogenous: Y , r , and HI P (not i) clears money market
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Exogenous Real Exchange RatesThe Classical Model of Price Determination
Monetary Approach: Key Ingredients
I exogenous real exchange rate
Qdef=
SP∗
P=⇒ S = Q
P
P∗
I Classical model of PI stable money demand: L(i ,Y )I H/P = L(i ,Y ) continuouslyI exogenous: Y , r , and HI P (not i) clears money market
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Exogenous Real Exchange RatesThe Classical Model of Price Determination
Monetary Approach: Key Ingredients
I exogenous real exchange rate
Qdef=
SP∗
P=⇒ S = Q
P
P∗
I Classical model of PI stable money demand: L(i ,Y )I H/P = L(i ,Y ) continuouslyI exogenous: Y , r , and HI P (not i) clears money market
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Exogenous Real Exchange RatesThe Classical Model of Price Determination
Purchasing Power Parity
I exogenous real exchange rate
I invariant real exchange rateI obviously false?
I relevant P and P∗ not observable
I implication: exchange rate proportional to relative price level
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Exogenous Real Exchange RatesThe Classical Model of Price Determination
Purchasing Power Parity
I exogenous real exchange rate
I invariant real exchange rateI obviously false?
I relevant P and P∗ not observable
I implication: exchange rate proportional to relative price level
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Exogenous Real Exchange RatesThe Classical Model of Price Determination
Purchasing Power Parity
I exogenous real exchange rate
I invariant real exchange rateI obviously false?
I relevant P and P∗ not observable
I implication: exchange rate proportional to relative price level
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Exogenous Real Exchange RatesThe Classical Model of Price Determination
Purchasing Power Parity
I exogenous real exchange rate
I invariant real exchange rateI obviously false?
I relevant P and P∗ not observable
I implication: exchange rate proportional to relative price level
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Exogenous Real Exchange RatesThe Classical Model of Price Determination
Purchasing Power Parity
I exogenous real exchange rate
I invariant real exchange rateI obviously false?
I relevant P and P∗ not observable
I implication: exchange rate proportional to relative price level
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Exogenous Real Exchange RatesThe Classical Model of Price Determination
Classical Model: Basic Predictions
I ↑ H =⇒I ↑ P proportionatelyI H/P unchanged
I ↑ i =⇒I ↓ LI ↑ P
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Exogenous Real Exchange RatesThe Classical Model of Price Determination
Classical Model: Basic Predictions
I ↑ H =⇒I ↑ P proportionatelyI H/P unchanged
I ↑ i =⇒I ↓ LI ↑ P
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Exogenous Real Exchange RatesThe Classical Model of Price Determination
Classical Model: Basic Predictions
I ↑ H =⇒I ↑ P proportionatelyI H/P unchanged
I ↑ i =⇒I ↓ LI ↑ P
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Exogenous Real Exchange RatesThe Classical Model of Price Determination
Classical Model: Basic Predictions
I ↑ H =⇒I ↑ P proportionatelyI H/P unchanged
I ↑ i =⇒I ↓ LI ↑ P
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Crude Monetary Approach
P =H
L(i ,Y )
P∗ =H∗
L∗(i∗,Y ∗)
P
P∗ =H/H∗
L(i ,Y )/L∗(i∗,Y ∗)
S = QH/H∗
L(i ,Y )/L∗(i∗,Y ∗)
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Crude Monetary Approach
P =H
L(i ,Y )
P∗ =H∗
L∗(i∗,Y ∗)
P
P∗ =H/H∗
L(i ,Y )/L∗(i∗,Y ∗)
S = QH/H∗
L(i ,Y )/L∗(i∗,Y ∗)
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Crude Monetary Approach
P =H
L(i ,Y )
P∗ =H∗
L∗(i∗,Y ∗)
P
P∗ =H/H∗
L(i ,Y )/L∗(i∗,Y ∗)
S = QH/H∗
L(i ,Y )/L∗(i∗,Y ∗)
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Crude Monetary Approach
P =H
L(i ,Y )
P∗ =H∗
L∗(i∗,Y ∗)
P
P∗ =H/H∗
L(i ,Y )/L∗(i∗,Y ∗)
S = QH/H∗
L(i ,Y )/L∗(i∗,Y ∗)
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Core Predictions
1% Increase In: H H∗ Y Y ∗ i i∗
Resulting ∆S : 1% -1% – + + –
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Money, Prices, and Exchange Rates
1
10
100
1000
10000
100000
1e+006
1e+007
1e+008
1e+009
01/90 01/91 01/92 01/93 01/94 01/95 01/96
Mon
ey, P
rice
s, a
nd E
xcha
nge
Rat
es: 0
1/90
= 1
Exchange RateCPI
Currency
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Early Studies
Estimated Response of the Spot Rate to:Study: Sample: H H∗ Y Y∗ i i∗
DEM/GBP
Frenkel (1976) 1921.02–1923.08 0.975 – – – 0.591 ←Bilson (1978b) 1972.01–1976.04 1.0013 -1.0081 -1.0184 0.9990 0.0228 ←Bilson (1978a) 1970.04–1977.05 1.0026 -0.9846 -0.9009 1.0183 1.3853 ←
USD/DEM
Hodrick (1978) 1973.04–1975.09 1.52 -1.39 -2.23 0.073 2.53 1.93GBP/USD
P&W (1979) 1972–1977 0.63 ← -0.77 ← 0.14 ←Note: The reported “responses” are money supply elasticities, income elasticities, and opportunity-cost semi-elasticities of the spot rate. Opportunity costs of holding money are proxied by interest rates or forward discounts. Adash indicates an omitted variable. A left arrow indicates that the domestic and foreign money demand parametersare constrained to equality.
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
MAFER with Forward Discount
L(i ,Y )/L(i∗,Y ∗) = L(i − i∗,Y ,Y ∗)
S = QH/H∗
L(i − i∗,Y ,Y ∗)
fd = i − i∗
S = QH/H∗
L(fd ,Y ,Y ∗)
Used by Frenkel (1976).
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Unanticipated ↑ H
tt0
H
0 tt0
P,S
0 tt0
H/P
0
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Unanticipated ↑ H
tt0
H
0 tt00
P,S
tt0
H/P
0
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Anticipated ↑ H
tt0ta
H
0 tt0ta
P,S
0 tt0ta
HP
0
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Anticipated ↑ H
tt0ta
H
0 tt0ta
P,S
0 tt0ta
H/P
0
Alan G. Isaac Monetary Approach
OutlineKey Ingredients of the Monetary Approach
The Crude Monetary Approach ModelExchange Rates and Anticipated Monetary Policy
References
Bilson, John F. O. (1978a, March). “The Monetary Approach toThe Exchange Rate—Some Empirical Evidence.” InternationalMonetary Fund Staff Papers 25, 48–75.
Bilson, John F. O. (1978b). “Rational Expectations and theExchange Rate.” See Frenkel and Johnson (1978), Chapter 5,pp. 75–96.
Frenkel, Jacob A. (1976, May). “A Monetary Approach to theExchange Rate: Doctrinal Aspects and Empricial Evidence.”Scandinavian Journal of Economics 78(2), 200–224. Reprintedin Frenkel and Johnson (1978).
Frenkel, Jacob A. and Harry G. Johnson, eds. (1978). TheEconomics of Exchange Rates: Selected Studies. Reading, MA:Addison-Wesley.
Alan G. Isaac Monetary Approach