The evidence presented here suggests that European Monetary System has indeed coincided with more predictable exchange rates (nominal and real) between France, Germany and Italy. But if increased monetary policy coordination is the main explanation, then it is surprising that the conditional variance of real interest differentials between these countries does not appear to have fallen (unless the disturbances are mostly real, in which case fixed rates are suboptimal). High onshore-offshore interest differentials for franc and lira assets, and the very slow convergence of intra-EMS inflation rates, suggest that capital controls have played a large role.
Society can sometimes make itself better off by appointing a central banker who does not share the social objective function, but instead places "too large" a weight on inflation-rate stabilization relative to employment stabilization. Although having such an agent head the central bank reduces the time-consistent rate of inflation, it suboptimally raises the variance of employment when supply shocks are large. Using an envelope theorem, we show that the ideal agent places a large, but finite, weight on inflation. The analysis also provides a new framework for choosing among alternate intermediate monetary targets.
This paper studies exchange rate behavior in models with moving long-run equilibria incorporating alternative price-adjustment mechanisms.The paper demonstrates that price-adjustment rules proposed by Mussa andby Barro and Grossman yield models that are empirically indistinguishable from each other. For speeds of goods-market adjustment that are "too fast," the Barro-Grossman rule appears to induce instability; but we argue that when the ruleis interpreted properly, models incorporating it are dynamically stable regardless of the speed at which disequilibriumis eliminated. The Barro-Grossman pricing scheme is shown to be a natural generalization, to a setting of moving long-run equilibria, of less versatile schemes proposed in earlier literature on exchange rate dynamics.
As the recent empirical studies surveyed here illustrate, it is very difficult to demonstrate that the exchange rate risk premium depends (through a portfolio balance channel) on the currency composition of outside assets. The existence of a 'portfolio balance effect' is a necessary condition for sterilized intervention to be a genuinely independent tool of monetary policy. This paper studies U.S./Canada data, and attempts to improve on earlier studies by using higher frequency (weekly) data and by implementing an appropriate instrumental variables technique (2S2SLS). However, we still fail to detect evidence of a portfolio balance effect.
Optimal monetary policy rules are derived in a rational expectations cum contracting framework. Monetary policy is redundant if wage setters exploit the incomplete current information embodied in today's nominal interest rate. However, the monetary authorities can save wage setters the costs of "indexing" to the interest rate. A contemporaneous money supply feedback rule is as effective as wage indexation. A lagged rule, relevant under a regime of money supply targeting, is also as effective if investors use the interest rate. Both rules have the same implications for the real interest rate as Poole's combination policy. However, the two rules have strikingly different implications for the nominal interest rate.
Negative net foreign asset and positions have been associated with a troublesome stability problem in flexible exchange rate regimes. In this paper, a symmetrically-specified, two-country, portfolio balance model is employed to provide some perspective on this problem. It is concluded that negative negative net foreign asset positions do not constitute an independent source of instability. Instability can arise only under nonrational expectations or because of destabilizing speculation.