International Finance and Open-Economy Macroeconomics

Since 1974 professor Giancarlo Gandolfo is full professor of International Economics, Faculty of Economics, Sapienza University of Rome. Since 2005 he is member of the scientific committee of University of Rome La Sapienza Press. His main areas of research are International monetary economics, continuous time econometrics, mathematical methods and models of economic dynamics. He is recipient of several research grants by national and international institutions.

1 Introduction.- 1.1 Old and New Approaches to International Finance.- 1.2 Structure of the Book.- 1.3 Small and Large Open Economies.- 1.4 References.- I The Basics.- 2 The Foreign Exchange Market.- 2.1 Introduction.- 2.2 The Spot Exchange Market.- 2.3 The Real Exchange Rate.- 2.4 The Effective Exchange Rate.- 2.5 The Forward Exchange Market.- 2.5.1 Introduction.- 2.5.2 Various Covering Alternatives; Forward Premium and Discount.- 2.6 The Transactors in the Foreign Exchange Market.- 2.6.1 Speculators.- 2.6.2 Non-Speculators.- 2.6.3 Monetary Authorities.- 2.7 Currency Derivatives.- 2.7.1 Futures.- 2.7.2 Options.- 2.7.3 Swap Transactions.- 2.8 Eurodollars and Xeno-Currencies.- 2.9 References.- 3 Exchange-Rate Regimes.- 3.1 The Two Extremes.- 3.2 The Bretton Woods System.- 3.2.1 The Monetary Authorities’ Intervention.- 3.3 Other Limited-Flexibility Systems.- 3.4 The Current Nonsystem.- 3.5 International Organisations.- 3.5.1 The IMF.- 3.5.2 The World Bank.- 3.6 References.- 4 International Interest-Rate Parity Conditions.- 4.1 Covered Interest Arbitrage, and Covered Interest Parity (CIP).- 4.2 Uncovered Interest Parity (UIP).- 4.3 Uncovered Interest Parity with Risk Premium.- 4.4 Real Interest Parity.- 4.5 Efficiency of the Foreign Exchange Market.- 4.6 Perfect Capital Mobility, Perfect Asset Substitutability, and Interest Parity Conditions.- 4.7 References.- 5 The Balance of Payments.- 5.1 Balance-of-Payments Accounting and Presentation.- 5.1.1 Introduction.- 5.1.2 Accounting Principles.- 5.1.3 Standard Components.- 5.1.3.1 Current Account.- 5.1.3.2 Capital Account.- 5.2 The Meaning of Surplus, Deficit, and Equilibrium in the Bal-ance of Payments.- 5.3 References.- 6 Real and Financial Flows in an Open Economy.- 6.1 Introduction.- 6.2 The Row Identities.- 6.3 The Column Identities.- 6.4 Derived Identities.- 6.5 Identities Are Only Identities.- II Flow Approaches.- 7 The Elasticity Approach.- 7.1 Introduction.- 7.2 Critical Elasticities and the So-Called Marshall-Lerner Condi-tion.- 7.2.1 The Balance of Payments in Domestic Currency....- 7.2.2 The Balance of Payments in Foreign Currency.- 7.2.3 Elasticity Optimism vs Pessimism.- 7.3 Foreign Exchange Market Equilibrium and Stability.- 7.3.1 Derivation of the Demand and Supply Schedules; Multiple Equilibria and Stability.- 7.4 Interrelations between the Spot and Forward Exchange Rate.- 7.4.1 The Various Excess Demand Schedules.- 7.4.2 Forward Market Equilibrium and the Spot Rate.- 7.4.3 The Monetary Authorities’ Intervention.- 7.5 References.- 8 The Multiplier Approach.- 8.1 The Basic Model.- 8.2 Balance-of-Payments Adjustment in the Case of an Exogenous Increase in Exports.- 8.3 Balance-of-Payments Adjustment in the Case of an Exogenous Increase in Imports.- 8.4 Intermediate Goods and the Multiplier.- 8.5 The Empirical Relevance of the Multiplier.- 8.6 The Transfer Problem.- 8.6.1 The Classical Theory.- 8.6.2 The Multiplier Theory.- 8.6.3 Observations and Qualifications.- 8.7 References.- 9 An Integrated Approach.- 9.1 Interaction between Exchange Rate and Income in the Adjustment Process.- 9.1.1 A Graphic Representation.- 9.1.2 Stability.- 9.1.3 Comparative Statics and the Transfer Problem.- 9.2 The J-Curve.- 9.3 The S-Curve.- 9.4 The Alleged Insulating Power of Flexible Exchange Rates, and the International Propagation of Disturbances.- 9.5 References.- 10 The Mundell-Fleming Model.- 10.1 Introductory Remarks.- 10.2 Fixed Exchange Rates.- 10.2.1 Graphic Representation of the Equilibrium Conditions.- 10.2.2 Simultaneous Real, Monetary and External Equilibrium. Stability.- 10.2.2.1 Observations and Qualifications.- 10.2.3 Comparative Statics.- 10.2.3.1 The Transfer Problem.- 10.2.3.2 Exchange-Rate Devaluation.- 10.3 Flexible Exchange Rates.- 10.4 References.- 11 Policy Implications of the Mundell-Fleming Model, and the Assignment Problem.- 11.1 Introduction.- 11.2 Internal and External Balance, and the Assignment Problem.- 11.2.1 The Assignment Problem.- 11.2.2 Observations and Qualifications.- 11.3 Flexible Exchange Rates.- 11.4 Perfect Capital Mobility.- 11.5 References.- III Stock and Stock-Flow Approaches.- 12 The Monetary Approach to the Balance of Payments and Related Approaches.- 12.1 Introduction.- 12.2 The Classical (Humean) Price-Specie-Flow Mechanism.- 12.3 The Monetary Approach to the Balance of Payments.- 12.3.1 The Basic Propositions and Implications.- 12.3.2 A Simple Model.- 12.3.3 Does a Devaluation Help?.- 12.3.4 Concluding Remarks.- 12.4 The New Cambridge School of Economic Policy.- 12.5 References.- 13 Portfolio and Macroeconomic Equilibrium in an Open Economy.- 13.1 Introduction.- 13.2 Asset Stock Adjustment in a Partial Equilibrium Framework.- 13.3 Portfolio and Macroeconomic Equilibrium under Fixed Exchange Rates.- 13.3.1 Introductory Remarks.- 13.3.2 A Simple Model.- 13.3.3 Momentary and Long-Run Equilibrium.- 13.4 Portfolio and Macroeconomic Equilibrium under Flexible Exchange Rates.- 13.4.1 Introductory Remarks.- 13.4.2 The Basic Model.- 13.4.3 Static Expectations.- 13.4.4 Rational Expectations and Overshooting.- 13.5 References.- 14 Growth in an Open Economy.- 14.1 Export-Led Growth.- 14.1.1 The Lamfalussy Model.- 14.1.2 The Beckerman Model.- 14.2 Growth and the Balance of Payments.- 14.3 Growth-Oriented Adjustment Programs.- 14.4 References.- IV The Exchange Rate.- 15 Exchange-Rate Determination.- 15.1 The Purchasing-Power-Parity Theory.- 15.1.1 The Harrod-Balassa-Samuelson Model.- 15.2 The Traditional Flow Approach.- 15.3 The Modern Approach: Money and Assets in Exchange-Rate Determination.- 15.3.1 The Monetary Approach.- 15.3.2 Sticky Prices, Rational Expectations, and Overshoot-ing of the Exchange-Rate.- 15.3.3 The Portfolio Approach.- 15.3.3.1 Interaction Between Current and Capital Ac-counts.- 15.4 The Exchange Rate in Macroeconometric Models.- 15.5 Exchange-Rate Determination: Empirical Studies.- 15.5.1 Introduction.- 15.5.2 The Reactions to Meese and Rogoff, and the Way Out.- 15.5.3 An Economy-Wide Model Beats the Random Walk.- 15.5.4 The Exchange Rate in Experimental Economics.- 15.6 Equilibrium Exchange Rates: BEERs, DEERS, FEERs and All That.- 15.7 References.- 16 Capital Movements, Speculation, and Currency Crises.- 16.1 Long-Term Capital Movements.- 16.2 Short-Term Capital Movements and Foreign Exchange Speculation.- 16.2.1 Flexible Exchange Rates and Speculation.- 16.3 Speculative Attacks, Currency Crises, and Contagion.- 16.3.1 A First Generation Model.- 16.3.2 A Second Generation Model.- 16.3.3 Third Generation Models.- 16.3.3.1 A Third Generation Model.- 16.3.3.1.1 The Crisis.- 16.3.3.1.2 The Stabilization Dilemma.- 16.3.4 The Indicators Approach. Can Crises Be Forecast?.- 16.3.5 Contagion.- 16.4 References.- 17 Fixed Vs Flexible Exchange Rates.- 17.1 The Traditional Arguments.- 17.2 The Modern View.- 17.2.1 Money Demand Shock.- 17.2.2 Aggregate Demand Shock.- 17.2.3 Aggregate Supply Shock.- 17.2.4 Conclusion.- 17.3 The Experience of the Managed Float.- 17.3.1 Introduction.- 17.3.2 New Light on an Old Debate?.- 17.4 The Vicious Circle Depreciation-Inflation.- 17.4.1 Introductory Remarks.- 17.4.2 The Depreciation-Inflation Circle.- 17.4.3 Is the Circle Really Vicious?.- 17.5 References.- V The Intertemporal Approach.- 18 The Intertemporal Approach to the Balance of Payments, and the Real Exchange Rate.- 18.1 Introduction: The Absorption Approach.- 18.2 Intertemporal Decisions, the Current Account, and Capital Flows.- 18.2.1 The Feldstein-Horioka Puzzle.- 18.2.2 The Harberger-Laursen-Metzler Effect Again.- 18.3 Intertemporal Approaches to the Real Exchange Rate.- 18.3.1 Introduction.- 18.3.2 The RAIOM Approach.- 18.3.3 The NATREX Approach: An Overview.- 18.3.4 A More Technical Presentation.- 18.3.4.1 Solution of the Model.- 18.3.4.1.1 The Medium Run.- 18.3.4.1.2 The Long Run.- 18.4 References.- 19 Recent Advances.- 19.1 Introduction.- 19.2 An Intertemporal Model with Endogenous Growth in an Open Economy.- 19.2.1 The Net Borrower Economy.- 19.3 Nominal Rigidities.- 19.3.1 Extensions.- 19.4 References.- VI International Monetary Integration.- 20 International Monetary Integration: Optimum Currency Areas and Monetary Unions.- 20.1 Introduction.- 20.2 The Theory of Optimum Currency Areas.- 20.2.1 The Traditional Approach.- 20.2.2 The Cost-Benefit Approach.- 20.2.3 The New Theory.- 20.2.4 Optimum for Whom?.- 20.3 The Common Monetary Unit and the Basket Currency.- 20.4 The Common Monetary Policy Prerequisite, the Inconsistent Triad, and Fiscal Policy.- 20.4.1 Fiscal Policy Coordination.- 20.5 The Single-Currency Problem.- 20.6 References.- 21 The European Monetary Union.- 21.1 The European Monetary System.- 21.1.1 The EMS and the Theory of Optimum Currency Areas.- 21.2 The Maastricht Treaty and the Gradual Approach to EMU.- 21.3 The Institutional Aspects.- 21.4 The Maastricht Criteria.- 21.5 The New Theory of Optimum Currency Areas and EMU...- 21.6 The Euro and the Dollar.- 21.7 References.- VII Problems of the International Monetary (Non) System.- 22 Key Events in the Postwar International Monetary System.- 22.1 Introductory Remarks.- 22.2 Convertibility.- 22.3 Eurodollars.- 22.4 Special Drawing Rights.- 22.5 Collapse of Bretton Woods.- 22.6 Petrodollars.- 22.7 Demonetization of Gold.- 22.8 EMS and EMU.- 22.9 The International Debt Crisis.- 22.10The Asian Crisis.- 22.11 References.- 23 International Liquidity, the Demand for International Reserves, and Xeno-Markets.- 23.1 Introductory Remarks.- 23.2 The Descriptive Approach.- 23.3 The Optimizing Approach.- 23.4 Is International Liquidity Still A Problem?.- 23.5 The Composition of International Reserves.- 23.6 The Analysis of Euro-Markets.- 23.6.1 The Fixed-Multiplier Approach.- 23.6.2 The Portfolio Approach to Euro-Markets.- 23.7 An Evaluation of the Costs and Benefits of Xeno-Markets.- 23.8 References.- 24 Current Problems.- 24.1 Introduction.- 24.2 International Policy Coordination.- 24.2.1 Policy Optimization, Game Theory, and International Coordination.- 24.2.2 The Problem of the Reference Model and the Obstacles to Coordination.- 24.3 The Debt Problem.- 24.4 The Asian Crisis.- 24.5 Proposals for the International Management of Exchange Rates.- 24.5.1 Introduction.- 24.5.2 McKinnon’s Global Monetary Objective.- 24.5.3 John Williamson’s Target Zones.- 24.5.4 The Tobin Tax.- 24.6 References.- VIII Appendices.- A Appendix to Chapter.- A.1 N-Point Arbitrage.- A.2 References.- B Appendix to Chapter 4.- B.1 Rational Expectations and Efficiency of the Foreign Exchange Market.- B.2 The Peso Problem.- B.3 The Siegel Paradox.- B.4 References.- C Appendix to Chapter 7.- C.1 The Critical Elasticities Condition.- C.1.1 The Simple Case.- C.1.2 The General Case.- C.1.3 Effects on the Terms of Trade.- C.2 The Stability of the Foreign Exchange Market.- C.3 A Model for the Simultaneous Determination of the Spot and Forward Exchange Rate.- C.4 References.- D Appendix to Chapter 8.- D.1 The Multiplier without Foreign Repercussions.- D.1.1 Basic Results.- D.1.2 The Balance of Payments.- D.2 Foreign Repercussions in a n-Country Model.- D.2.1 The General Model.- D.2.2 Stability Analysis.- D.2.3 Comparative Statics. A Comparison between the Various Multipliers.- D.2.4 The Balance of Payments.- D.3 Intermediate Goods and the Multiplier.- D.3.1 Different Requirements of Intermediate Goods.- D.3.2 Identical Requirements of Intermediate Goods.- D.4 The Transfer Problem.- D.5 References.- E Appendix to Chapter 9.- E.1 A Simplified Version of the Laursen and Metzler Model.- E.1.1 The BB and RI? Schedules.- E.1.2 The Dynamics of the System.- E.1.3 Comparative Statics: The Transfer Problem.- E.2 The J-curve.- E.3 The Original Two-Country Version of the Laursen and Metzler Model.- E.3.1 The Basic Model.- E.3.2 Stability.- E.3.3 Comparative Statics.- E.3.3.1 The International Propagation of Disturbances.- E.3.3.2 The Transfer Problem.- E.4 References.- F Appendix to Chapter 10.- F.1 The Mundell Fleming Model under Fixed Exchange Rates.- F.1.1 The Slopes of the Various Schedules.- F.1.2 The Study of Dynamic Stability.- F.1.3 Comparative Statics.- F.1.3.1 The Transfer Problem.- F.1.3.2 An Exchange-Rate Devaluation.- F.2 The Mundell-Fleming Model under Flexible Exchange Rates.- F.3 References.- G Appendix to Chapter 11.- G.1 Monetary and Fiscal Policy Under Fixed Exchange Rates.- G.1.1 The Static Model.- G.1.2 The Assignment Problem.- G.1.3 A Generalization of the Assignment Problem.- G.2 Monetary and Fiscal Policy Under Flexible Exchange Rates.- G.3 Perfect Capital Mobility.- G.4 References.- H Appendix to Chapter 12.- H.1 The Classical Theory.- H.2 The Monetary Approach to the Balance of Payments.- H.2.1 The Effects of a Devaluation.- H.3 References.- I Appendix to Chapter 13.- I.1 Partial-Equilibrium Asset Adjustment.- I.2 Portfolio and Macroeconomic Equilibrium under Fixed Ex-change Rates.- I.2.1 The Dynamics of the Long-Run Equilibrium.- I.2.2 The Stability Conditions.- I.3 Portfolio and Macroeconomic Equilibrium under Flexible Exchange Rates.- I.3.1 The Basic Model.- I.3.2 Static Expectations.- I.3.2.1 Short-Run Equilibrium.- I.3.2.2 Long-Run Equilibrium.- I.3.3 Rational Expectations.- I.4 References.- J Appendix to Chapter 14.- J.1 Exports, Growth, and the Balance of Payments.- J.2 Growth-Oriented Adjustment Programs.- J.2.1 The Monetary Model.- J.2.2 The Real Growth Model.- J.2.3 The Integrated Model.- J.3 References.- K Appendix to Chapter 15.- K.1 PPP and the Harrod-Balassa-Samuelson Effect.- K.2 The Dornbusch Overshooting Model.- K.3 The Modern Approach to Exchange-Rate Determination.- K.3.1 The Monetary Approach.- K.3.2 The Portfolio Approach.- K.3.3 Empirical Studies.- K.3.4 Currency Substitution.- K.4 Chaos Theory and the Exchange Rate.- K.5 References.- L Appendix to Chapter 16.- L.1 A First-Generation Model.- L.2 A Second-Generation Model.- L.3 References.- M Appendix to Chapter 17.- M.1 The Shock-Insulating Properties of Fixed and Flexible Exchange Rates.- M.2 The Effects of Various Shocks.- M.2.1 Money Demand Shock.- M.2.2 Aggregate Demand Shock.- M.2.3 Aggregate Supply Shock.- M.2.4 Conclusion.- M.3 The Intertemporal Approach.- M.4 References.- N Appendix to Chapter 18.- N.1 The Two-period Case.- N.2 An Infinite Horizon Model.- N.3 The RAIOM Approach to the Real Exchange Rate.- N.4 The NATREX Approach.- N.4.1 The SOFC Rule and the Investment Function.- N.4.1.1 The Optimal Feedback Control Rule.- N.4.1.2 The Sub-Optimal Feedback Control (SOFC) Rule.- N.4.2 Analysis of the NATREX Equilibrium.- N.4.2.1 The Medium Run.- N.4.2.2 The Long Run.- N.5 References.- O Appendix to Chapter 19.- O.1 The Dynamic Optimization Problem.- O.2 The Net Borrower Nation.- O.2.1 Steady-State Stability and Comparative Dynamics..- O.3 Nominal Rigidities.- O.3.1 The Consumption-Based Price Index.- O.3.2 The Composite Nontraded Good, and Its Demand Function.- O.3.3 The Intertemporal Optimization Problem.- O.3.3.1 Steady-State Equilibrium.- O.3.3.2 Short-run Effects of an Unanticipated Money Shock.- O.4 References.- P Appendix to Chapter 20.- P.1 Fiscal Policy in a Monetary Union.- P.2 Fiscal Coordination.- P.3 References.- Q Appendix to Chapter 23.- Q.1 The Maximization of a Welfare Function.- Q.2 Intertemporal Maximization and the Normative Theory of Eco-nomic Policy.- Q.3 The Composition of International Reserves.- Q.4 A Portfolio Model of the Euro-Market.- Q.5 References.- R Appendix to Chapter 24.- R.1 International Policy Coordination.- R.2 Target Zones.- R.3 The Tobin Tax.- R.3.1 A Simple Model.- R.4 References.