an empirical examination of the implications of arbitrage pricing theory abstract this paper presents a comprehensive set of tests of the implications of the arbitrage pricing theory we find unlike previously reported results a very limited relationship between the expected returns and the covariance factor loadings measures of risk furthermore unique variance measures of risk while generally making only small contributions to the explanation of asset returns turn out to be significant about as frequently as the coveriance measures of risk which is inconsistent with the arbitrage pricing theory model the intercept tests are more mixed but provide only limited support to the model

quantity aggregation in consumer demand analysis when physical quantities are observed a method for estimating price and income elasticities from cross section data devised by deaton 1986 1987 1988 makes implicit use of the hicks composite commodity theorem recognition of this fact allows theoretically rigorous definition of aggregate composite quantities a comparison of elasticities of hicks composite with elasticities of simple physical quantity measures for the ivory coast and the united states demonstrates that use of physical quantity measures can be severely misleading when commodity heterogeneity is substantial copyright 1990 by mit press

exchange rate policies and endogenous time preference a dynamic analysis of a small open economy abstract the effects of exchange rate policies are examined for a small open economy with endogenous rate of time preference using optimizing framework and introducing money into the utility function it is shown that a depreciation of the domestic currency generates a surplus in the current account it also leads to an increase in consumption and a decrease in the holdings of real balances in the long run

semiparametric estimation and consumer demand this paper considers the implementation of semiparametric methods in the empirical analysis of consumer demand the application is to the estimation of the engel curve relationship and uses the british family expenditure survey household composition is modelled using an extended partially linear framework this is shown to provide a useful method for pooling non parametric engel curves across households of different demographic composition c 1998 john wiley sons ltd

a note on factor analysis and arbitrage pricing theory abstract this paper examines some theoretical and empirical properties of factor analysis and spells out their implications for arbitrage pricing theory apt doubts on the appropriateness of conventional factor analytic procedures for testing apt are raised on theoretical as well as empirical grounds

measuring the spatial price differences in china with regional price parity methods the measurement of prices has been an important field in economics and a spatial price index is very useful in comparing the standards of living and well being across regions in a country this paper intends to measure the regional price parities rpps across different provincial areas in china with an urban sample of 140 goods and services in 2015 according to the framework of the international comparison program icp methodology the results show that the rpps that were estimated with commonly used approaches such as the gini elteto koves szulc geks geary khamis gk and weighted country product dummy wcpd are only slightly different the rpps of three regions including guangdong shanghai and zhejiang are greater than 1 with beijing 1 while the other 27 regions are all lower than 1 which represents price levels that are less than beijing in the extrapolation of the rpps from 2000 to 2014 a significant descending trend is found for the standard deviation series of the rpps over time that shows that the price differences across regions decreased during the extrapolating period this finding provides evidence of a phenomenon of spatial price converging in china finally a study on the deflation of provincial aggregates with the rpps reveals that the spatial price adjustment will change the ranks or relative importance of different regions in the country especially the measurement of income inequality proves that the gini coefficients of provincial income deflated by the rppgeks are all lower than the gini coefficients of unadjusted incomes

international income inequality measuring ppp bias by estimating engel curves for food there are large differences between rich and poor people in the world this is of major concern to economists as well as to policy makers the magnitude of the dif ferences however depends on the measure used for comparisons to illustrate per capita income in china is more than five times larger if one uses penn world table pwt 1 incomes rather than exchange rate based ex incomes in this paper we study pwt incomes which aim at correcting for price level dif ferences across countries and identify the bias in them by estimating engel curves for food furthermore we study the relationship between the bias and the income of a country the pwt produces purchasing power parity ppp adjusted incomes and thus the associated bias is referred to as the ppp bias having estimated the bias in pwt incomes we provide new estimates of real income and refer to these as the engel curve ec incomes by comparing the estimated ec incomes and the pwt incomes the issue of how the bias influences estimated inequality is discussed finally we discuss whether ex incomes which simply transform each country s nominal income into one common currency provide better estimates of income than do pwt incomes this paper reports three main findings first there is substantial and systematic ppp bias in the pwt incomes the poorer the country the more its income tends to be overestimated 2 second the ppp bias causes a substantial and robust underesti mation of international inequality the gini index increases substantially when one adjusts for the bias third whereas pwt incomes provide better estimates than the ex incomes for the richer countries the ex incomes which implicitly assume that ppp holds provide better estimates for the poorer countries as we know that price levels differ across countries there is consensus that the seminal work on establishing the pwt was a well founded initiative and the data have been extensively used 3 still although many studies rely on pwt data few focus on the ppp bias in this dataset some contributors focus on one component of the bias however the so called substitution bias and use macro data to measure this

inflationary finance in an open economy abstract models of inflationary finance that consider trade and capital flows generally conclude that openness curtails the ability of governments to impose the inflation tax due to currency substitution this paper models two channels that allow central banks to increase inflation tax revenue by opening the economy first central banks can open the capital account subject to a reserve requirement on capital inflows revenue maximization produces a smaller reserve requirement on foreign capital inflows that on domestic deposits second central banks can impose prior import deposits to broaden the monetary base in order to use the inflation tax on imports as an alternative to tariff revenue

quality quantity and spatial variation of price this paper develops and implements a method for estimating price elasticities of demand using cross sectional household survey data geographically clustered households report unit values which when corrected for quality effects and for measurement error indicate the underlying spatial variation in prices and can be matched to variation in demand patterns a simple model of quality choice is proposed while the correction for measurement error exploits the clustered design of such surveys data from a 1979 household survey from the ivory coast are used to estimate price elasticities for beef meat fish cereals and starches copyright 1988 by american economic association

aggregation effects on price and expenditure elasticities in a quadratic almost ideal demand system while it is well known that demand elasticities calculated at the macro level will in general differ from those calculated at the micro level because of aggregation effects there remain the questions of how large the effects are and how they vary with the degree of nonuniformity in the income distribution we explore those questions with models based on a quadratic version of the almost ideal demand system we investigate the elasticity differences theoretically and then calibrate the models and generate numerical results using income data for seven countries with widely different distributions the aggregation effects are found generally to be rather small even with highly nonuniform income distributions

some results in the theory of arbitrage pricing this paper derives a stronger version of huberman s recent preference free pricing theorem this pricing result relates the expected return on an asset to its factor responses and the covariance structure of the residuals from a linear factor model it must characterize any infinite asset economy in which no arbitrage opportunities are present whether or not the factor model has uncorrelated residuals this result provides the intuition for the role of residual risk in the pricing model and eliminates some classes of arbitrage opportunities still present under huberman s bound some applications to empirical tests and performance measurement are also discussed the arbitrage pricing theory is one of several financial pricing models which attempts to explain the cross sectional variation in expected returns on assets in certain respects it is similar to the capital asset pricing model but there are both substantive and subtle differences one of the key advantages of the apt is that it derives a simple linear pricing relation approximating that in the capm without some of the latter s objectionable assumptions perhaps the key disadvantage of the apt is that it provides no clues as to what might be important factors nor as to how to interpret the factor premiums which appear in the pricing equation this paper serves several purposes after reviewing the linear factor model formulation in section i it derives in section ii a stronger version of huberman s 9 recent preference free pricing theorem this pricing result relates the expected return on an asset to its factor responses and the covariance structure of the residuals this relation must characterize any infinite asset economy in which no arbitrage opportunities are present whether or not a linear factor model with uncorrelated residuals is the appropriate returns generating mechanism section iii specializes this result by eliminating the effects of residual covariances and compares the results here to those of previous apt models when applied to the standard linear factor model with uncorrelated residuals this new pricing bound eliminates arbitrage opportunities which remain under huberman s bound this result also provides for the first time the intuition for the role of residual risk in the approximate pricing relation section v provides an interpretation of the factor premiums and gives a valid asset pricing model interpretation to the apt which is consistent with merton s

measuring poverty in a growing world or measuring growth in a poor world the extent to which growth reduces global poverty has been disputed for 30 years although there are better data than ever before controversies are not resolved a major problem is that consumption measured from household surveys which is used to measure poverty grows less rapidly than consumption measured in national accounts in the world as a whole and in large countries particularly india china and the united states in consequence measured poverty has fallen less rapidly than appears warranted by measured growth in poor countries one plausible cause is that richer households are less likely to participate in surveys but growth in the national accounts is also upward biased and consumption in the national accounts contains large and rapidly growing items that are not consumed by the poor and not included in surveys so it is possible for consumption of the poor to grow less rapidly than national consumption without any increase in measured inequality current statistical procedures in poor

risk and capital asset prices abstract this paper is an empirical examination of the statistical significance of the residual variance of individual assets as compared with the covariance of returns with various market portfolio proxies in predicting expected return the data and analysis we present suggest that measures of covariance are no more significant than residual variance in predicting expected return in this sense our paper is not supportive of the sharpe lintner or black versions of the capital asset pricing model

effects of inflation on the pattern of international trade this paper integrates a transactions based model of money with a real trade model and examines how steady state inflation affects the direction and size of international trade the effects of inflation work through changes in supplies of labour and capital which are chosen jointly with production and consumption by utility maximizing households if production exhibits constant returns to scale in domestically mobile factors then it is unlikely that the economy will produce both of the two traded goods for certain rates of inflation small changes can have dramatic effects on the direction of trade for other rates of inflation the volume of trade is affected when money is held for transactions purposes and factor supplies are endogenous changes in inflation can cause changes in the pattern of trade that do not reflect real underlying changes in comparative advantage

an equilibrium model of exchange rate determination and asset pricing with nontraded goods and imperfect information this paper presents a two country model with maximizing households stochastic production stochastic money growth and perfect capital mobility because of the presence of nontraded goods households in different countries consume different goods analytic solutions are presented for the nominal exchange rate the real exchange rate nominal interest rates and real interest rates it is shown that the model is compatible with some important features of the real world behavior of exchange rates when households are imperfectly informed about the distribution of money growth the exchange rate exhibits patterns of overshooting and is more volatile than the ratio of the money stocks copyright 1987 by university of chicago press

measuring substitution bias in international comparisons based on additive purchasing power parity methods abstract this paper shows that additive purchasing power parity ppp methods such as geary khamis are subject to substitution bias as a result geary khamis comparisons tend to underestimate per capita income differentials across countries the magnitude of the bias is measured for a cross section of 64 countries using international comparison programme icp data geary khamis overestimates some poorer countries per capita incomes relative to richer countries by as much as 70 these results have important implications for much empirical work in development and international economics since geary khamis is the ppp method used by the world bank imf oecd icp and the penn world table

a critical reexamination of the empirical evidence on the arbitrage pricing theory this paper demonstrates that the roll and ross rr and other previously published tests of the apt are subject to several basic limitations there is a general nonequivalence of factor analyzing small groups of securities and factor analyzing a group of securities sufficiently large for the apt model to hold it is found that as one increases the number of securities the number of factors determined increases this increase in the number of factors with larger groups of securities cannot readily be explained by a distinction between priced and nonpriced risk factors as it is impermissible to carry out tests on whether a given risk factor is priced using factor analytic procedures the apt model as exposited by ross 17 18 and extended by huberman 9 has provided the basis of an extensive literature as for example brown and weinstein 1 chen 3 hughes 10 ingersoll 11 jobson 12 reinganum 15 roll and ross rr 16 and shanken 17 to mention but a few it has also been treated in a more general context by chamberlain and rothschild 2 our purpose here is not to comment on this collection of papers many of which are unpublished but to reexamine the evidence presented by rr and point out major pitfalls involved in the empirical methodology employed by them and others who have followed their lead rr claim that on theoretical and more importantly on empirical grounds arbitrage pricing theory apt is an attractive alternative to the capital asset pricing model capm the apt it is argued requires less stringent and presumably more plausible assumptions is more readily testable since it does not require the measurement of the market portfolio and may be better able to explain the anomalies found in the application of the capm to asset returns the acceptability of the apt like that of the capm or any other theory ultimately depends on its ability to explain the relevant empirical evidence our subsequent discussion will show that many of the prqblems associated with the capm are also present in the apt context and that its ability to explain the relevant empirical evidence is not markedly superior moreover it raises questions not only about the rr and related empirical investigations of the apt but also about the testability of that theory in the present state of the art a major part of the problem results from the necessity to break down the universe being analyzed through the apt model this is forced upon the investigator by the fact

the empirical foundations of the arbitrage pricing theory abstract this paper uses maximum likelihood factor analysis of large cross sections to examine the validity of the arbitrage pricing theory apt we are unable to explain the expected returns on firm size portfolios although we do explain the expected returns on portfolios formed on the basis of dividend yield and own variance where risk adjustment using the usual capm market proxies fails we also compare alternate versions of the apt and sharply reject the hypothesis that basis portfolios formed to mimic the factors span the mean variance frontier of the individual assets

prices engel curves and time space deflation impacts on poverty and inequality in vietnam many developing countries lack spatially disaggregated price data some analysts use no price methods by using a food engel curve to derive the deflator as that needed for nominally similar households to have equal food shares in all regions and time periods this method cannot be tested in countries where it is used as a spatial deflator since they lack suitable price data in this paper data from vietnam are used to test this method against benchmarks provided by multilateral price indexes calculated from repeated spatial price surveys deflators from a food engel curve appear to be a poor proxy for deflators obtained from multilateral price indexes to the extent that such price indexes reliably compare real living standards over time and space these results suggest that estimates of the level location and change in poverty and inequality would be distorted if the engel method deflator was used in their stead

the world distribution of income falling poverty and convergence period we estimate the world distribution of income by integrating individual income distributions for 138 countries between 1970 and 2000 country distributions are constructed by combining national accounts gdp per capita to anchor the mean with survey data to pin down the dispersion poverty rates and head counts are reported for four specific poverty lines rates in 2000 were between one third and one half of what they were in 1970 for all four lines there were between 250 and 500 million fewer poor in 2000 than in 1970 we estimate eight indexes of income inequality implied by our world distribution of income all of them show reductions in global inequality during the 1980s and 1990s

true world income distribution 1988 and 1993 first calculation based on household surveys alone the paper derives world income or expenditure distribution of individuals for two years 1988 and 1993 it is the first paper to calculate world distribution for individuals based entirely on household survey data from 91 countries and adjusted for differences in purchasing power parity between the countries measured by the gini index inequality increased from an already very high 63 in 1988 to 66 in 1993 the increase was driven more by rising differences in mean incomes between the countries than by rising inequalities within countries the most important contributors were rising urban rural differences in china and slow growth of rural incomes in south asia compared to several large developed market economies

what do normative indices of multidimensional inequality really measure we argue that normative indices of multidimensional inequality do not only measure a distribution s extent of inequity i e the gaps between the better off and the worse off but also its extent of inefficiency i e the non realized mutually beneficial exchanges of goods we provide a decomposition that allows quantifying these two parts of inequality exact formulas of the inequity and inefficiency components are provided for a generic class of social welfare functions the inequity component turns out to be a two stage measure which applies a unidimensional inequality measure to the vector of well being levels we critically discuss two prominent transfer principles viz uniform majorization and correlation increasing majorization in the light of the decomposition a decomposition of inequality in human development illustrates the analysis

a simple approach to arbitrage pricing theory the following sections are included introductionarbitrage pricingdiscussionreferencesdiscussion notes on the arbitrage pricing theorypure arbitrage pricing theoryapproximate arbitrage and the aptapproximate factor modelsthe competitive equilibrium version of the aptconclusionnotereferences this abstract was borrowed from another version of this item

new tests of the apt and their implications this paper provides new tests of the arbitrage pricing theory apt test results appear to be extremely sensitive to the number of securities used in the two stages of the tests of the apt model new tests also indicate that unique risk is fully as important as common risk while these tests have serious limitations they are inconsistent with the apt

stock return anomalies and the tests of the apt this paper shows that the empirical tests of the arbitrage pricing theory apt model are very sensitive to the anomalies observed in january in the stock returns data there is a strong seasonal pattern in the estimates of the risk premia from the apt model the most important implication of the findings in this paper is that the apt model can explain the risk return relation mostly for january once the january returns are excluded from the data there is no significant relation between the expected stock returns and the risk measures predicted by the apt model it is now a very well known phenomenon that stock returns exhibit a peculiar seasonal pattern while such a seasonal pattern in stock returns is an interesting phenomenon in itself and has yet to be fully explained there is a serious implication of the observed seasonality in stock returns on the tests of the assetpricing models 1 tinic and west 17 for example report that the risk return relation described by the capital asset pricing model capm also exhibits a similar seasonality in january a result rozeff and kinney 16 report as well more importantly however they show that only one month january shows a consistently positive and reliable relation between expected return and risk once the data for january are excluded from the analysis of the risk return tradeoff the estimates of risk premia are no longer reliably different from zero although tinic and west do not offer an explanation for their findings their results raise serious questions about the empirical tests of the capm and ultimately its validity as a viable model to explain the pricing of risky assets the purpose of this paper is to investigate the impact of stock return seasonality on the empirical tests of the arbitrage pricing theory apt a number of researchers argue on both theoretical and empirical grounds that the apt is a good alternative to the capm although there is a growing body of empirical literature on the apt the empirical tests of the apt thus far have produced inconclusive results and a good deal of controversy it now seems appropriate to

differences in relative prices and international differences in growth rates the new growth literature following paul m romer 1986 and robert e lucas jr 1988 has formulated models in which growth rates can differ systematically across countries a large empirical literature has used cross sectional techniques to examine the cause of international differences in growth rates this paper examines whether this work has used data which have been constructed in such a way as to introduce inadvertently a spurious correlation between growth and income levels this effect occurs because relative prices evolve because of different rates of technological progress in different industries many of the new growth models assume single goods or goods produced by the same technology so this phenomenon has so far escaped analysis if technological progress is more rapid in some sectors than others relative prices will change during the process of development the change of relative prices has two effects on measured growth rates first the choice of base prices affects the growth rate this phenomenon is sometimes called the gerschenkron effect second using any base prices or weights introduces a spurious correlation between income and growth less developed countries would tend to have lower growth rates not because they grew more slowly but because of data construction techniques for the sake of simplicity these phenomena will be called the gerschenkron or the level effect and the spurious correlation effect 3 this paper examines the international comparison program icp and the penn world tables pwt which are based on the icp the penn world tables are the data most widely used in empirical studies of international differences in economic growth both the icp and pwt use international prices to adjust for differences in the purchasing power of currencies these prices most closely resemble hungarian prices using such prices tends to produce time series with lower growth rates than those in the national accounts for countries less developed than hungary conversely the growth rates would be higher for countries more developed than hungary however the growth rates of poorer countries are not systematically lower in the penn world tables the paper examines why the growth rates are not distorted and makes some specific recommendations for data construction and use virginia polytechnic institute and state university blacksburg va 24061 0316 part of this work was supported by a grant from the institute of international studies at brown university and by a summer internship at the division of international finance at the federal reserve board i am grateful to peter garber david weil oded galor and anonymous referees for helpful comments alan heston and robert summers have also helped me understand icp and pwt methodology of course i alone am responsible for any mistakes in this paper iexamples include steve dowrick and duc tho nguyen 1989 robert j barro 1991 j bradford de long and lawrence h summers 1991 and n gregory mankiw et al 1992 2a series of papers by christina d romer 1986a b 1989 has already emphasized the importance of data construction techniques in another context 3there is a third effect a real acceleration effect caused by shifting consumption patterns and the reallocation of resources between sectors growth accountants such as angus maddison 1987 adjust estimates of total factor productivity for this sort of shift william j baumol et al 1989 have also referred to this phenomenon for an analysis in terms of a simple multisector solow model see nuxoll 1992a

income and energy use in bangladesh a household level analysis abstract we examine how energy use at the household level moves with income in bangladesh using the 2010 wave of bangladesh household income and expenditure survey data our analyses indicate a u shaped relationship of both electricity use and other types of energy use combined with household expenditure the findings imply that as income grows households increase their energy expenditure less than proportionally up to a threshold level of income beyond the threshold income energy use increases as a proportion of income particularly for electricity use we identify the threshold turning point for both electricity and other types of energy use based on the current level of expenditure and its growth reaching the turning point would require 17years for the former category but only 7years for the latter group

an explicit bound on individual assets deviations from apt pricing in a finite economy abstract ross s arbitrage pricing theory apt is a tractible and reasonable alternative to the mean variance model nonetheless understanding of the theory has been obscured by the complexity of the sequence economy models used for motivation by contrast we give a simple and direct derivation of the apt in a finite economy using an explicit bound on the deviations from apt prices across assets a coarse calculation shows that theoretical deviations from apt pricing are negligible in our economy

price unit value and quality demanded abstract given the paucity of quality price data it is common to rely on unit value average expenditure per unit as a proxy for price but this is an imperfect proxy if households respond to price increases by substituting to lower quality goods this paper draws on survey data that contain both unit value and price to estimate the severity of quality substitution in indonesia finding that it is prevalent the paper next calculates price elasticities that correct for quality substitution evaluating and ultimately rejecting a commonly used method for calculating price elasticities using only unit value data finally it demonstrates that quality substitution can result in biased price elasticities even when price is perfectly observed

using engel curves to estimate bias in the canadian cpi as a cost of living index semiparametric engel curves are used to infer bias in the canadian cpi as a cost of living index the budget share of food has long been used as an indicator of welfare we compare households with the same levels of cpi deflated total expenditure over the period 1978 2000 differences in the expenditure share of food are attributed to the cpi failing to capture changes in costs of living we employ a novel econometric approach using a single index penalized linear spline model over the period we find that the cpi overstated changes in the cost of living between 1 33 and 1 86 for the four household types considered jel classification d1 c1 l utilisation des courbes d engel pour evaluer la distorsion de l ipc en tant qu indice du cout de la vie on utilise les courbes semi parametriques d engel pour identifier le biais de l ipc comme indice du cout de la vie au canada la part du budget qui va a la nourriture a depuis longtemps ete utilisee comme un indicateur de bien etre on compare des menages qui ont les memes niveaux de depenses totales degonflees par l ipc pour la periode de 1978 a 2000 les differences dans la portion des depenses qui va a la nourriture sont attribuees au fait que l ipc ne saisit pas les changements dans les couts de la vie on emploie une approche econometrique inedite utilisant une fonction spline lineaire avec penalites pour produire un seul indice sur l etendue de la periode on decouvre que l ipc surevalue les changements dans le cout de la vie de 1 33 a 1 86 pour cent pour les quatre types de menages etudies

price stickiness along the income distribution and the effects of monetary policy abstract monetary shocks have distributional consequences if they affect relative prices across goods consumed by different households we document that the prices of the goods consumed by high income households are stickier and less volatile than those of the goods consumed by middle income households following a monetary policy shock the estimated impulse responses of high income households consumer price indices are about one third smaller than those of the middle income households we evaluate the implications of these findings in a quantitative multi sector new keynesian model featuring heterogeneous households the distributional consequences of monetary policy shocks are large and similar to those in the econometric model

estimating real income in the united states from 1888 to 1994 correcting cpi bias using engel curves this paper provides the first estimates of overall cpi bias prior to the 1970s and new estimates of bias since the 1970s it finds that annual cpi bias was 0 1 percent between 1888 and 1919 and rose to 0 7 percent between 1919 and 1935 annual cpi bias was 0 4 percent in the 1960s and then rose to 2 7 percent between 1972 and 1982 before falling to 0 6 percent between 1982 and 1994 the findings imply that we have underestimated growth rates in true income in the 1920s and 1930s and in the 1970s

on fiscal deficits the real exchange rate and the world rate of interest we use a full general equilibrium two country two period model with perfect capital markets and intertemporal optimization and perfect foresight underlying private consumer behaviour in both countries to analyse effects of pure fiscal policy we demonstrate that higher government budget deficits in one country caused by a cut in commodity taxes today balanced by an equal present value increase tomorrow will not be offset one for one by higher private savings because of pure substitution effects triggered by the change in the intertemporal terms of trade the tax change causes the country with the increased government deficit will therefore run a larger current account deficit which in turn unambiguously leads to higher world real interest rates whether a real appreciation results in the country with the higher deficit is shown to depend on the metzler condition for an undereffected transfer if we spend more on our goods than they spend on our goods on the margin government deficits will lead to an appreciation of the exchange rate of the country with the government deficit and vice versa

quadratic engel curves and consumer demand this paper presents a model of consumer demand that is consistent with the observed expenditure patterns of individual consumers in a long time series of expenditure surveys and is also able to provide a detailed welfare analysis of shifts in relative prices a nonparametric analysis of consumer expenditure patterns suggests that engel curves require quadratic terms in the logarithm of expenditure while popular models of demand such as the translog or the almost ideal demand systems do allow flexible price responses within a theoretically coherent structure they have expenditure share engel curves that are linear in the logarithm of total expenditure we derive the complete class of integrable quadratic logarithmic expenditure share systems a specification from this class is estimated on a large pooled data set of u k households models that fail to account for engel curvature are found ro generate important distortions in the patterns of welfare losses associated with a tax increase

macroeconomic policy exchange rate dynamics and optimal asset accumulation the paper develops a model of exchange rate and current account determination for a small economy peopled by infinitely lived utility maximizing households in this setting a central bank purchase of foreign exchange has no real effects when central bank foreign reserves earn interest at the world rate and proceeds are returned to the public in contrast an increase in the monetary growth rate does have real effects even in the long run the model developed here implies that an increase in government spending may lead to a surplus on current account the external adjustment process predicted by the model is one in which consumption real balances and external assets all rise or fall simultaneously