Exchange Rate Economics: Theories and Evidence

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Currency substitution and portfolio balance models 187 Trade account + 0 – Capital account 0 t 0 t n Time t n t 0 + – Time (a) (b) S 1 Exchange rate S 0 0 t 0 t n Time (c) Figure 7.9 The adjustment profiles of (a) the trade account,(b) the capital account and (c) the exchange rate. 7.4.3 An increase in the supply of domestic bonds: fiscal policy Consider now a once-and-for-all increase in the supply of bonds. (Although we have not explicitly modelled the public sector,this could follow from a bondfinanced increase in government expenditure.) An increase in the supply of bonds increases wealth and,for a given domestic interest rate i,requires an increase in the exchange rate S to maintain the foreign exchange market in equilibrium; thus, the FF schedule in Figures 7.10 and 7.11 shifts rightwards to FF ′ . For a given value of the exchange rate the increased supply of domestic bonds will require an increase in the domestic interest rate to maintain bond market equilibrium: the BB schedule shifts rightwards and the new equilibrium is at Y. The increased bond supply exceeds any wealth-induced increase in bond demand and the domestic interest rate is unambiguously raised. The effect on the exchange rate of an increase in the stock of domestic bonds is in fact ambiguous. This is because the rise in the domestic interest rate will induce a reduced demand for foreign assets and this will tend to offset the increased demand for foreign fixed price bonds due to the wealth effect. The ultimate effect depends on whether F and B or B and M are the closer substitutes. 7.4.3.1 New bond issue and currency depreciation Assuming that B and M are better substitutes than F and B,the issue of B causes currency depreciation at Y in Figure 7.10,despite higher i attracting some capital inflow. This comes about because residents are,by assumption,not strongly attempting to swap foreign bonds, F ,for B to obtain the higher rate of interest. The adjustment from Y to the new long-run equilibrium at,say,Z will be the same as for the open market operation – lower wealth reducing the demand for B and F .
188 Currency substitution and portfolio balance models Y T Initial BoT surplus C99 T Y9 T C T C9 T F9 B B9 Final BoT deficit C99 T Y T 9 A B S 2 S 3 X S 1 F X Y Z F F9 C T Y T , C T C9 T Y T B B9 i Figure 7.10 An increase in the supply of bonds and currency depreciation. Note BoT: balance of trade. Y T C9 T C0 T F B Final BoT surplus Initial BoT deficit S 1 S 3 S 2 X Z Y C9 T Y T1 Y T1 C T F 1 B 1 B 1 C T C99 T YT B F 1 F Y T ,C T i Figure 7.11 An increase in the supply of bonds which causes currency appreciation. Note BoT: balance of trade. On the production and consumption side too,the outcome is the same as with the open market operation. Thus,at Y real wealth will have fallen,agents will be saving and real wealth will be reaccumulated over time,pushing C T C T first to the right and then back to the left as the level of actual wealth recovers. Moreover, as the price of non-traded goods will have risen owing to excess demand for them
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Exchange Rate Economics Exchange Ra
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Firstpublished2007 by Routledge 2Pa
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Contents List of figures List of ta
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Figures 1.1 The balance of payments
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Figures 13.6 Fourth generation spec
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Preface This book is the second edi
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2 Introduction Although the textboo
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4 Introduction (orders to buy/sell
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6 Introduction Table 1.3 Currency d
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8 Introduction a truly flexible exc
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10 Introduction this has to be sati
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12 Introduction likely that the rel
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14 Introduction or F (1 + i) = S (1
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16 Introduction Consider now a fall
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18 Introduction The empirical evide
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20 Introduction (mean and variance)
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22 Introduction (a) (b) 0.3 0.25 0.
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24 Introduction clusters or that it
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26 Introduction 0.1 0.05 0 -0.05 -0
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28 Introduction 1.9 Exchange rate r
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30 Introduction fixed versus flexib
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32 Introduction influences. For exa
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34 Introduction 1.11 The determinan
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36 Introduction In the standard OCA
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38 Introduction most transactions i
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40 Purchasing power parity and the
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3 The economics of the PPP puzzle I
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70 The economics of the PPP puzzle
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4 The flexible price monetary appro
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96 The flexible price monetary appr
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98 The flexible price monetary appr
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100 The flexible price monetary app
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5 The sticky-price monetary model I
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108 The sticky-price monetary model
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6 The monetaryapproach to the excha
Page 151 and 152: 136 Empirical evidence on the monet
Page 169 and 170: Table 6.5 SEM equations: United Kin
Page 181 and 182: 7 Currencysubstitution models and t
Page 183 and 184: 168 Currency substitution and portf
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Page 215 and 216: 200 Real exchange rate determinatio
Page 243 and 244: 228 Equilibrium exchange rates rate
Page 245 and 246: 230 Equilibrium exchange rates A nu
Page 247 and 248: 232 Equilibrium exchange rates long
Page 249 and 250: 234 Equilibrium exchange rates 5.1
Page 251 and 252: 236 Equilibrium exchange rates term
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238 Equilibrium exchange rates 0.30
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240 Equilibrium exchange rates Detk
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242 Equilibrium exchange rates US i
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244 Equilibrium exchange rates The
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246 Equilibrium exchange rates 9.6.
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248 Equilibrium exchange rates 9.6.
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250 Equilibrium exchange rates Conc
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252 The new open economy macroecono
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11 The new open economy macroeconom
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290 Target zone models 12.1 The bas
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292 Target zone models stochastic c
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294 Target zone models moves from 2
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296 Target zone models where A 1 an
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298 Target zone models expected dev
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300 Target zone models % expected d
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302 Target zone models MacDonald (2
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304 Target zone models for the DM-l
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306 Target zone models explicit ban
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308 Target zone models Table 12.1 F
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310 Target zone models short-term i
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312 Target zone models the UK short
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314 Speculative attack models and c
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340 Market microstructure approach
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15 Spot and forward exchange rates
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Notes 1 Introduction: some basic co
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398 Notes 4 Although the split betw
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400 Notes 3 The fact that the utili
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402 Notes 15 This result is familia
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404 Notes 6 Where ∫ ∞ vg(v) E(v
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406 References Artis,M. and M. Lewi
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408 References Bergin,P.,R. Glick a
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410 References Calvo,G.A. and C.A.
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412 References Clark,P.B. and R. Ma
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414 References Detken,C.,A. Dieppe,
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416 References Edwards,S. and I. Ma
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418 References Fischer,S. (2001),
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420 References Frieden,J.P.G. and E
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422 References Granger,C.W. and T.
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424 References Hooper,P. and J. Mor
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426 References Kearney,C. and R. Ma
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428 References Lewis,K. (1988),‘T
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430 References MacDonald,R. (2002),
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432 References Mark,N.C. (2001),Int
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434 References Obstfeld,M. and K. R
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436 References Roll,R. (1979),‘Vi
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438 References Tauchen,G.E. and M.
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Index Abadir,K. 389 Abuaf,N. 60 Adl
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442 Index Diba,B. 177-8 Dickey,D.A.
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444 Index Gagnon,J. 212 Gali,J. 128
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446 Index Miller,M.H. 120,123,128,1
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448 Index purchasing power parity (
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450 Index trade: interbank trade 34
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Exchange Rate Economics: Theories and Evidence

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