a multivariate posterior odds approach to assessing competing exchange rate models a horse race is performed among competing models of bilateral exchange rates between the united states and canada the united kingdom germany and japan the authors compute posterior odds that any of the competing models is true using standard bayes rule formulae the distinguishing feature of this horse race is that the posterior odds incorporate the information contained in the covariances among the forecast errors of competing models it is found in contrast to meese and rogoff 1983 that the random walk model is dominated by one of the dornbusch overshooting model the flexible price monetarist model or the hooper morton model for all bilateral rates for almost all of the sample the authors are able to replicate the random walk dominance results by forcing the posterior odds to ignore covariance information so that in a sense their results encompass those of earlier studies copyright 1991 by mit press

why interest rates react to money announcements an explanation from the foreign exchange market abstract when the fed announces a money supply greater than had been expected interest rates rise why one explanation is that the market raises its estimate of the future rates of money growth and inflation and bids up nominal interest rates we offer contrary evidence on such days the dollar appreciates not depreciates an alternative explanation is that the market perceives the change in the money stock as a transitory fluctuation that the fed will reverse in the future the anticipated future tightening raises today s real interest rate causes a capital inflow and appreciates the dollar the result in fact observed

monetary policy homeostasis and the transmission mechanism philip howrey 1967 william poole 1970 and john kareken 1970 initiated a formal debate over monetary policy using some variant of an is lm model thomas sargent and neil wallace 1975 extend this work by incorporating a lucas type aggregate supply function and rational expectations in spite of the effort spent in following up on the seminal work by howrey poole and kareken little progress has been made in resolving the debate the central theme of this paper is that the lack of progress is the result of ignoring homeostasis and the nature of the transmission mechanism in order to illustrate the importance of homeostasis and the transmission mechanism this paper extends the standard is lm framework in two ways first it introduces a homeostatic mechanism that generates shortrun responses which correspond to standard is lm behavior and long run responses which reflect full employment second it provides for alternative transmission mechanisms by dropping the assumption that markets clear continuously the paper is organized as follows the model is developed in the next section the following section examines the role of homeostasis and the transmission mechanism in the debate over policy the final section presents the conclusions

interest rates and currency prices in a two country world abstract this paper is a theoretical study of the determination of prices interest rates and currency exchange rates set in an infinitely lived two country world which is subject both to stochastic endowment shocks and to monetary instability formulas are obtained for pricing all equity claims nominally denominated bonds and currencies and these formulas are related to earlier closely related results in the theories of money finance international trade

the vanishing liquidity effect of money on interest analysis and implications for policy this paper seeks to re examine the effects of money on interest rates the earlier literature on this topic determined fairly well the pattern of response of interest rates to changes in money growth the notable studies of cagan 1972 cagan and gandolfi 1969 and gibson 1970 served to establish the professions stylized pattern as presented in section i section ii presents new evidence on the subject and finds that the old empirical generalizations no longer hold specifically the results suggest that the initial liquidity effect of faster money growth is likely to be offset within the month following the monetary policy change sections iii and iv investigate the reasons for the changing pattern of monetary effects on interest rates and discuss the policy implications of the new pattern

the structure of open economy macro models abstract the objectives here include a rigorous investigation of a walras law in an open economy b the generality or non generality of the monetary approach to the balance of payments c the logical consistency of the traditional keynesian models of the balance of payments d the relationship if any between a government budget imbalance and the balance of payments and e perhaps most importantly the underlying cause s of a non zero balance of payments many of the conclusions differ from the conventional wisdom

currency fluctuations in the post bretton woods era the international monetary landscape that has emerged since the felling of bretton woods is characterized by a hybrid exchange rate system that lies somewhere between the textbook polar cases of a gold standard and a pure float this system has relatively flexible exchange rates between major countries active central bank intervention in the market for the major currencies and predominantly fixed exchange rates relative to the dollar or to some basket of currencies for less developed countries and newly industrializing nations the majority of research on currency markets since the early 1970s has focused on the characteristics of flexible exchange rates under this hybrid regime my thesis is that this research has been unsuccessful the proportion of monthly or quarterly exchange rate changes that current models can explain is essentially zero even after the fact forecasts that use actual values instead of forecasted values of the explanatory variables cannot explain major currency movements over the post bretton woods era this result is quite surprising since exchange rate changes would be entirely unpredictable only in very special cases of the theoretical models discussed as the discussion below will argue it is not a general implication of market efficiency that exchange rates follow a random walk process 1

was it real the exchange rate interest differential relation over the modern floating rate period in this paper we explore the relationship between real exchange rates and real interest rate differentials in the united states germany japan and the united kingdom contrary to theories based on the joint hypothesis that domestic prices are sticky and monetary disturbances are predominant we find little evidence of a stable relationship between real interest rates and real exchange rates we consider both in sample and out of sample tests one hypothesis that is consistent with our findings is that real disturbances such as productivity shocks may be a major source of exchange rate volatility this paper investigates the empirical relationship between major currency real exchange rates and real interest rates over the modern post march 1973 flexible rate experience the exchange rates examined here include the dollar mark dollar yen and dollar pound rates our two major findings are as follows first the data do not indicate a strong correspondence between real interest rate differentials short term or long term and real exchange rates this finding appears to conflict with the predictions of most monetary and portfolio balance models of exchange rate determination though the conflict can be substantially reconciled if aggregate disturbances are primarily real in nature i e changes in productivity tastes etc it is true that in many cases the sign of the estimated exchange rate interest rate differential relationship is consistent with the possible predominance of financial market disturbances but the relationship is not stable enough to be statistically significant second although one does find some evidence of a unit root in both real exchange rates and long term but not shortterm real interest differentials these two series do not appear to be linearly cointegrated hence the nonstationarity or near nonstationarity in the two series cannot be attributed to the same factor in section i we briefly describe a class of small scale monetary models of exchange rate determination the importance of this class of models for empirical work derives from its strong predictions about how the exchange rate will move

sources of fluctuations in real and nominal exchange rates this paper attempts to distinguish empirically real versus nominal sources of fluctuations in real and nominal exchange rates the distinction is obtained by imposing the following restriction on the bivariate vector autoregression of real and nominal exchange rates over the current flexible rate period nominal shocks are required to have no permanent effect on the level of the real exchange rate given this identification scheme the author analyzes the dynamic effects and relative importance of real and nominal shocks with regards to exchange rates the findings indicate that real shocks dominate nominal shocks for both exchange rate series over short and long frequencies copyright 1992 by mit press

gathering information before signing a contract after being offered a contract an agent has the possibility to observe the state of nature this enables him to refuse the contract in unfavorable states but burdens him with an observation cost the authors show that the principal offers a contract in which the agent has no incentive to observe the state of nature and they explore its terms later they show that the principal finds it profitable to organize competition between several agents even though he has monopoly power and can push a single agent down to his reservation utility copyright 1992 by american economic association

information provision before a contract is offered this paper considers an agency model in which the agent can update the principal s belief before the contract is offered we identify that the agent who has a bad potential to perform the task has a small chance to receive information rent but if he receives it he receives a large amount thus the agent may choose to provide more information that shifts the principal s belief to the negative direction if the prior belief is optimistic

the loanable funds theory and the dynamics of exchange rates the mundell model revisited abstract this paper shows that mundell s model of perfect capital mobility is logically consistent only in the framework of the loanable funds theory it then develops a loanable funds version of the mundell model and shows that exchange rate overshooting or undershooting naturally occurs in this corrected version of the mundell model

the value of ignorance this article provides a new perspective on the information structure of an agent in a standard model of adverse selection before the contracting takes place the agent has the opportunity to gather private information on a relevant parameter that affects final payoffs i allow for the possibility that the agent remains uninformed with some probability the agent s optimal choice of information structure is derived and it is shown that in the case of two states of nature the possibility of remaining ignorant has a positive strategic value for the agent since a poor information structure generates strategic benefits there will be no equilibrium in which the agent is perfectly informed even if additional information is costless at the margin

the impact of regulatory quality and corruption on residential electricity prices in the context of electricity market reforms abstract the european electricity markets have been undergoing significant regulatory reforms since the introduction of the first liberalisation directive in 1996 theory predicts that liberalisation promotes cost efficient production and competition and hence leads to lower prices the goal of this paper is to assess the impact of regulatory quality and non compliance with the law on electricity prices in the context of electricity market reforms we address problems of endogeneity by using the blundell blond system gmm estimator and find that vertical integration and market concentration lower end user prices all else equal moreover improving regulatory quality and reducing corruption both have a negative impact on prices when holding other factors constant the intensity of the reforms has limited impact on electricity prices when these reforms are introduced in an institutional environment characterised by high levels of corruption and low quality regulation

anomalies foreign exchange most all behavior can be explained by assuming that agents have stable well defined preferences and make rational choices consistent with those preferences in markets that eventually clear an empirical result qualifies as an anomaly if it is difficult to rationalize or if implausible assumptions are necessary to explain it within the paradigm this column will present a series of such anomalies readers are invited to suggest topics for future columns by sending a note with some reference to or better yet copies of the relevant research comments on anomalies printed here are also welcome the address

towards a loanable funds amended liquidity preference theory of the exchange rate and interest rate abstract the objective is to develop a unified theory of the exchange rate and interest rate using a loanable funds amended liquidity preference approach in order to provide a new perspective on many puzzling facts associated with the post bretton woods international economy it is shown that i a monetary expansion can initially raise the interest rate but depreciate the home currency ii real demand shocks can cause interest rate and exchange rate overshooting iii an infinite interest elasticity for capital flows cannot cause exchange rate overshooting if an extended marshall lerner condition holds iv the home currency can appreciate when the current account is negative if the extended marshall lerner condition is not satisfied and v changes in the disequilibrium regime will cause instability in the estimates of reduced form coefficients

trade flow lags monetary and fiscal policy and exchange rate overshooting abstract in this paper model a is constructed that combines trade slow lags with the model in the appendix to dornbusch s seminal paper on exchange rate dynamics here output is free to vary and inflation is determined by a simple phillips curve mechanism it turns out that because of the trade slow lags monetary expansion causes interest rates to decline but the exchange rate need not oveshoot as one would expect whereas fiscal policy always produces overshooting it follows that monetary policy may be a less important source of exchange rate variability than is commonly believed and fiscal policy more important

the buffer stock notion in monetary economics not the least of harry johnson s contributions to our discipline was the series of survey papers on aspects of monetary economics which he produced during the 1960s and 1970s it is no exaggeration to say that the way in which the literature of monetary economics is organised even now follows the design which johnson first set out in 1962 and built on in the subsequent decade nevertheless the subject has not stood still and one of the more interesting developments of the last few years has involved the introduction of what has been variously described as the disequilibrium money shock absorber or as i prefer to call it the buffer stock notion into monetary economics the development of this line of thought was getting underway before johnson s untimely death much of it indeed under the auspices of his own research programme at the lse even so this did not happen early enough for the relevant ideas to be put in their proper niche by johnson himself and the buffer stock approach is not yet fully integrated into the mainstream of monetary economics much of the relevant literature is empirical concerned with modelling particular aspects of the monetary experience of specific countries hence it is fragmented and contains few papers which attempt a coherent account of just what this approach is and how it relates to other approaches to monetary analysis although essays by goodhart 1982a b and judd and scadding 1982a contain important discussions of these issues to the best of my knowledge only jonson 1976a and knoester 1979a have devoted entire papers solely to this central issue and these are relatively inaccessible and hence less widely known than they deserve to be in this lecture i shall attempt to give a brief account of the essentials of this approach first i shall sketch out its microeconomic background and then i shall discuss those theoretical characteristics which differentiate it from the neo austrian analysis of robert e lucas jr and his associates as well as from the conventional keynesian approach to monetary economics last but by no means least i shall argue that it yields simple theoretical insights into important empirical and policy related issues which are troublesome for alternative approaches in short my tribute to harry

regulating a monopolist with unknown costs we consider the problem of how to regulate a monopolistic firm whose costs are unknown to the regulator the regulator s objective is to maximize a linear social welfare function of the consumers surplus and the firm s profit in the optimal regulatory policy prices and subsidies are designed as functions of the firm s cost report so that expected social welfare is maximized subject to the constraints that the firm has nonnegative profit and has no incentive to misrepresent its costs we explicitly derive the optimal policy and analyze its properties in their classic papers dupuit 2 and hotelling 5 considered pricing policies for a bridge that had a fixed cost of construction and zero marginal cost they demonstrated that the pricing policy that maximizes consumer well being is to set price equal to marginal cost and to provide a subsidy to the supplier equal to the fixed cost so that a firm would be willing to provide the bridge this first best solution is based on a number of informational assumptions first the demand function is assumed to be known to both the regulator and to the firm while the assumption of complete information may be too strong the assumption that information about demand is as available to the regulator as it is to the firm does not seem unnatural a second informational assumption is that the regulator has complete information about the cost of the firm or at least has the same information about cost as does the firm this assumption is unlikely to be met in reality since the firm would be expected to have better information about costs than would the regulator as weitzman has stated an essential feature of the regulatory environment i am trying to describe is uncertainty about the exact specification of each firm s cost function in most cases even the managers and engineers most closely associated with production will be unable to precisely specify beforehand the cheapest way to generate various hypothetical output levels because they are yet removed from the production process the regulators are likely to be vaguer still about a firm s cost function 12 p 684 as this observation suggests it is natural to expect that a firm would have better information regarding its costs than would a regulator the purpose of this paper is to develop an optimal regulatory policy for the case in which the regulator does not know the costs of the firm one strategy that a regulator could use in the absence of full information about costs is to give the firm the title to the total social surplus and to delegate the pricing decision to the firm in pursuing its own interests which would then be to maximize the total social surplus the firm would adopt the same marginal cost pricing strategy that the regulator would have imposed if the regulator had