Short-Run Independence of Monetary Policy Under Pegged Exchange Rates and Effects of Money on Exchange Rates and Interest Rates / Alan C. Stockman, Lee E. Ohanian.

By:

Stockman, Alan C

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w4517.Publication details: Cambridge, Mass. National Bureau of Economic Research 1993.Description: 1 online resource: illustrations (black and white)Subject(s):

F41 - Open Economy Macroeconomics

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Abstract: Economists generally assert that countries sacrifice monetary independence when they peg their exchange rates. At the same time, central bankers frequently assert that pegging an exchange rate does not eliminate the independence of monetary policy. This paper examines the effects of money-supply changes on exchange rates, interest rates, and production in an optimizing two-country model in which some sectors of the economy have predetermined nominal prices in the short run and other sectors have flexible prices. Money-supply shocks have liquidity effects both within and across countries and induce a cross-country real-interest differential. The model predicts that liquidity effects are highly non-linear and are not likely to be captured well empirically by linear models, particularly those involving only a single country. The most striking implication of the model is that countries have a degree of short-run independence of monetary policy even under pegged exchange rates.

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Previous	nber w4514 Short-Term Contracts as a Monitoring Device /	nber w4515 A Small Open Economy in Depression: Lessons from Canada in the 1930s /	nber w4516 The Importance of Precautionary Motives in Explaining Individual and Aggregate Saving /	nber w4517 Short-Run Independence of Monetary Policy Under Pegged Exchange Rates and Effects of Money on Exchange Rates and Interest Rates /	nber w4518 Beauty and the Labor Market /	nber w4519 Index-Option Pricing with Stochastic Volatility and the Value of Accurate Variance Forecasts /	nber w4520 A Test of Efficiency for the S&P Index Option Market Using Variance Forecasts /	Next

November 1993.

Economists generally assert that countries sacrifice monetary independence when they peg their exchange rates. At the same time, central bankers frequently assert that pegging an exchange rate does not eliminate the independence of monetary policy. This paper examines the effects of money-supply changes on exchange rates, interest rates, and production in an optimizing two-country model in which some sectors of the economy have predetermined nominal prices in the short run and other sectors have flexible prices. Money-supply shocks have liquidity effects both within and across countries and induce a cross-country real-interest differential. The model predicts that liquidity effects are highly non-linear and are not likely to be captured well empirically by linear models, particularly those involving only a single country. The most striking implication of the model is that countries have a degree of short-run independence of monetary policy even under pegged exchange rates.