Michael Devereux

Professor
NBER, Research Associate
CEPR, Research Associate
Royal Bank Chair
Federal Reserve Bank of Dallas, Senior Research Advisor
International Journal of Central Banking, Co-editor

I have been at UBC since 1992, and currently I am a Professor in the Vancouver School of Economics. I obtained my PhD from Queen’s University. My main area of interest is in International Macroeconomics and International Finance.

Currently, my research activity is in the area of exchange rate determination, the link between exchange rates and prices, and international aspects of monetary and fiscal policy. Recently, I have also worked on international financial linkages and their role in the global financial crisis.

Most international economists do a lot of traveling, and I am no exception. I have ongoing research projects with quite a few co-authors in different parts of the world. I have been a visitor at many universities in North America, Europe and Asia. I have also had many connections with central banks and international organizations, particularly the Bank of Canada, the Bank for International Settlements (Hong Kong), and the Federal Reserve Bank of Dallas.

Please click on paper titles for abstracts and full text downloads.

[Go to Recent Publications] [Go to Older Publications]

WORKING PAPERS

Open economy macro theory says that when a country is subject to idiosyncratic macro shocks, it should have its own currency and a flexible exchange rate.  But recently, in many countries policy rates have been pushed down close to the lower bound, limiting the ability of policy-makers to use accommodative monetary policy, even in open economies with flexible exchange rates. In this paper, we show that if the zero bound constraint is binding and policy lacks an effective `forward guidance’ mechanism, a flexible exchange rate system may be inferior to a single currency area, even when there are country-specific macro shocks. When monetary policy is constrained by the zero bound, under independent currencies with flexible exchange rates, the exchange rate exacerbates the impact of shocks.  Remarkably, this may hold true even if only a subset of countries are constrained by the zero bound, and other countries are free to adjust their monetary policy.  In order for a regime of multiple currencies to dominate a single currency area in a liquidity trap environment, it is necessary to have forward guidance in monetary policy.

[go to paper]

We study a newly released data set of scanner prices for food products in a large Swiss online supermarket. We find that average prices change about every two months, but when we exclude temporary sales, prices are extremely sticky, changing on average once every three years. Non-sale price behavior is broadly consistent with menu cost models of sticky prices. When we focus specifically on the behavior of sale prices, however, we find that the characteristics of price adjustment seems to be substantially at odds with standard theory.

[go to paper]

In this paper we study two long-standing puzzles in the International Finance literature: the fact that the real exchange rate (RER) is very volatile (RER volatility puzzle) and that it covaries negatively with domestic consumption relative to foreign consumption (Backus-Smith puzzle). To understand the two puzzles we depart from the existing literature by focusing on a disaggregated analysis of consumption and RER. First, using region-level data for a large number of developed and developing economies we document the characteristics of the two puzzles in cross-country and within-country data. We then develop a combined model of inter-regional and international trade. The model exhibits variations in inter-regional as well as in inter-national consumption and real exchange rates. We show that with a combination of within country and across country shocks and endogenous non-tradability the model can rationalize the two puzzles, and does so in both international and intra-national dimensions.

[go to paper]

The zero interest rate bound introduces a new dimension to the international policy trilemma. International financial market openness may render monetary policy ineffective, even within a system of fully flexible exchange rates, because shocks that lead to a `liquidity trap’ in one country are propagated through financial markets to other countries. But monetary policy effectiveness may be restored by the imposition of capital controls. We derive an optimal monetary policy response to a global liquidity trap in the presence of capital controls. We show that, even though capital controls may facilitate effective monetary policy, capital controls are not generally desirable in welfare terms.

[go to paper]

The size of gross external portfolio holdings has among many countries increased substantially over the recent past. Over the same period the volatility of inflation has declined in most countries. Many previous papers argue that financial globalisation has led to improved policy-making and lower inflation. This paper makes the case that there could be causation running in the other direction. We present theory and empirical evidence indicating that more stable inflation leads to a substantial rise in the size of gross international financial positions, and an increase in financial globalisation.

[go to paper]

Models of risk-sharing predict that relative consumption growth rates across locations should be positively related to real exchange rate growth rates across the same areas. We investigate this hypothesis using a new multi-country and multi-regional data set. Within countries, we find evidence for risk-sharing: episodes of high relative regional consumption growth are associated with regional real exchange rate depreciation. Across countries however, the association is reversed: relative consumption and real exchange rates are negatively correlated. We define this reversal as a `border’ effect and show that it accounts for 53 percent of the deviations from full risk-sharing. Since cross-border real exchange rates involve different currencies, it is natural to ask how much of the border effect is accounted for by movements in exchange rates? We find that over one-third of the border effect is due to nominal exchange rate fluctuations. We develop a simple open economy model that is consistent with the importance of nominal exchange rate variability in accounting for deviations from cross-country risk-sharing.

[go to paper]


RECENT PUBLICATIONS

Forthcoming

With integrated trade and financial markets, a collapse in aggregate demand in a large country can cause ‘natural real interest rates’ to fall below zero in all countries, giving rise to a global ‘liquidity trap’. This paper explores the policy choices that maximize the joint welfare of all countries following such a shock, when governments cooperate on both fiscal and monetary policy. Adjusting to a large negative demand shock requires raising world aggregate demand, as well as redirecting demand towards the source (home) country. The key feature of demand shocks in a liquidity trap is that relative prices respond perversely. A negative shock causes an appreciation of the home terms of trade, exacerbating the slump in the home country. At the zero bound, the home country cannot counter this shock. Because of this, it may be optimal for the foreign policy-maker to raise interest rates. Strikingly, the foreign country may choose to have a positive policy interest rate, even though its ‘natural real interest rate’ is below zero. A combination of relatively tight monetary policy in the foreign country combined with substantial fiscal expansion in the home country achieves the level and composition of world expenditure that maximizes the joint welfare of the home and foreign country. Thus, in response to conditions generating a global liquidity trap, there is a critical mutual interaction between monetary and fiscal policy.

[go to paper]


2013

We study a newly created panel data set of relative prices for a large number of consumer goods among 31 European countries over a 15‐year period. The data set includes eurozone members both before and after the inception of the euro, floating exchange rate countries of Western Europe, and emerging market economies of Eastern and Southern Europe. We find that there is a substantial and continuing deviation from purchasing power parity (PPP) at all levels of aggregation, both for traded and non‐traded goods, even among eurozone members. Real exchange rates (RER) exhibit two clear properties in the sample (a) they are closely tied to gross domestic product (GDP) per capita relative to the European average, at all levels of aggregation and for both cross country time series variation; (b) they are highly positively correlated with variation in the relative price of non‐traded goods. We then construct a simple two‐sector endowment economy model of real exchange rate determination which exhibits these two properties, calibrated to match the data. Simulating the model using the historical relative GDP per capita for each country, we find that for most countries, there is a close fit between the actual and simulated real exchange rate. In terms of policy relevance, the model can offer suggestions of the degree to which real exchange rates in Europe (both in and out of the eurozone) have been overvalued (by approximately 15% in Greece and Portugal and 6% in Italy and Spain).

[go to paper]

Historically, the world economy has been dominated by a single currency accepted in the exchange of goods and assets among countries. In recent decades, the U.S. dollar has played this role. The dollar acts as a “vehicle currency” in the sense that agents in nondollar economies will generally engage in currency trade indirectly using the U.S. dollar instead of using direct bilateral trade among their own currencies. A vehicle currency is desirable when there are transactions costs of exchange. This article constructs a dynamic general equilibrium model of a vehicle currency. We explore the nature of the efficiency gains arising from a vehicle currency and show how it depends on the total number of currencies in existence, the size of the vehicle currency economy, and the monetary policy followed by the vehicle currency’s government. We find that there can be significant welfare gains to a vehicle currency in a system of many independent currencies. But these gains are asymmetrically weighted toward the residents of the vehicle currency country. The survival of a vehicle currency places natural limits on the monetary policy of the vehicle currency country.

[go to paper]


2012

This paper documents some previously neglected features of sectoral shares at business cycle frequencies in OECD economies. In particular, we find that the nontraded sector share of output is as volatile as aggregate GDP, and that for most countries, the nontraded sector is distinctly countercyclical. While the standard international real business cycle model has difficulty in accounting for these properties of the data, an extended model which allows for sectoral adjustment along both the intensive and extensive margins does a much better job in replicating the volatilities and co-movements in the data. In addition, the model provides a closer match between theory and data with respect to the correlation between relative consumption growth and real exchange rate changes, a key measure of international risk-sharing.

[go to paper]

It is often suggested that currency unions unduly inhibit the efficient adjustment of real exchange rates. Recently, this has been seen as a key failure of the Eurozone. This paper presents evidence that throws doubt on this conclusion. Our evidence suggests that real exchange rate movement within the Eurozone was at least as compatible with efficient adjustment as the behavior of real exchange rates for the floating rate countries outside the Eurozone. This interpretation is consistent with a model in which nominal exchange rate movements give rise to persistent deviations from the law of one price in traded goods.

[go to paper]

Standard models of international risk sharing with complete asset markets predict a positive association between relative consumption growth and real exchange-rate depreciation across countries. The striking lack of evidence for this link the consumption/real-exchange-rate anomaly or Backus-Smith puzzle – has prompted research on risk-sharing indicators with incomplete asset markets. That research generally implies that the association holds in forecasts, rather than realizations. Using professional forecasts for 28 countries for 1990-2008 we find no such association, thus deepening the puzzle. Independent evidence on the weak link between forecasts for consumption and real interest rates suggests that the presence of ‘hand-to-mouth’ consumers may help to resolve the anomaly.

[go to paper]


2011

Recent experience suggests that the operation of monetary policy in emerging market economies is severely limited by the presence of financial constraints. This is seen in the tendency to follow contractionary monetary policy during crises, and the observation that these countries pursue much more stable exchange rates than do high income advanced economies, despite having a more volatile external environment. This Paper analyses the use of monetary policy in an open economy in which exchange rate sensitive collateral constraints may bind in some states of the world. The appeal of the model is that it allows for a complete analytical description of the effects of collateral constraints, and admits a full characterization of welfare-maximizing monetary policy rules. The model can explain the two empirical features of emerging market monetary policy described above – in particular, that optimal monetary policy may be pro-cyclical under binding collateral constraints, and an economy with large external shocks may favour a fixed exchange rate, even though flexible exchange rates are preferred when external shocks are smaller.

[go to paper]

This paper examines demand spillovers in a two country open economy model to a demand shock newline (emanating from a single, source country) sufficiently large to push one or both countries into a liquidity trap. The zero lower bound on nominal interest rates keeps the central bank in the source country from fully adjusting monetary policy. We describe a two country New Keynesian model with sufficient home bias so as to exclude symmetric movements in response to demand shocks. We study conditions under which a liquidity trap in one country might spillover to a trading partner. We study, under which conditions, a liquidity trap in one country will lead to a liquidity trap in another country. We also show conditions under which a liquidity trap in another country can spillover into an output expansion in a trading partner.

[go to paper]

This paper investigates the use of fiscal policy in response to a large negative aggregate demand shock which may push the global economy into a liquidity trap. Fiscal policy may be an effective tool to respond to a liquidity trap, but its international spillover effects may operate quite differently from its domestic effects. We derive the optimal cooperative fiscal response to a global liquidity trap in a two country world economy. Surprisingly, we find that the optimal fiscal spending response for a partner country to a negative aggregate demand shock in a source country may be negative. If fiscal policy can be chosen under policy commitment, the optimal response involves current fiscal expansion combined with future fiscal contraction, after the liquidity trap has ended.

[go to paper]

This paper develops a simple approximation method for computing equilibrium portfolios in dynamic general equilibrium open economy macro models. The method is widely applicable, simple to implement, and gives analytical solutions for equilibrium portfolio positions in any combination or types of asset. It can be used in models with any number of assets, whether markets are complete or incomplete, and can be applied to stochastic dynamic general equilibrium models of any dimension, so long as the model is amenable to a solution using standard approximation methods. We first illustrate the approach using a simple two-asset endowment economy model, and then show how the results extend to the case of any number of assets and general economic structure.

[go to paper]

We construct a model of the international transmission of ‘liquidity trap’ shocks, and examine the case for international coordination of fiscal policy to respond to the liquidity trap. Integrated financial markets tend to propagate liquidity traps. In a global environment, fiscal policy may be effective in raising GDP when the economy is stuck in a liquidity trap, but it does so in a ‘beggar thy neighbor’ fashion; when one economy is in a liquidity trap, the cross country spillover effect of fiscal policy is negative. We examine the welfare optimizing policy response to a liquidity trap when countries coordinate on fiscal policy. Fiscal policy may be an effective tool in responding to a liquidity trap, although it is never optimal to use fiscal expansion sufficiently to fully eliminate a downturn. Moreover, there is little case for coordinated global fiscal expansion. For the most part, the country worst hit by a liquidity trap shock should use its own policies to respond, without much help from foreign policies.

[go to paper]

The global financial crisis has undermined many economists’ views about the benefits of open financial markets. Anecdotal evidence seems to indicate that financial linkages may propagate shocks during crises. This paper develops a simple two-country model in which financial liberalisation across countries takes place in the presence of credit market distortions within countries. Countries may be subject to macro risk coming from productivity shocks and direct shocks to the credit system (‘financial shocks’). Three different degrees of financial linkages between countries are examined. It is shown that the type of financial integration is critical for both macroeconomic outcomes and welfare. In particular, financial integration in bond markets alone may increase aggregate consumption volatility and reduce welfare. Financial integration in both bond and equity markets generates high positive co-movement across countries, but is welfare-improving.

[go to paper]

The global experience of the last two years has shaken conventional beliefs in the benefits of unfettered financial markets. In response to the Asian crisis of a decade ago, most Asian economies had switched to an apparently more durable system of financing economic growth. But this did not prevent Asian countries from suffering considerably from the global financial crisis. Moreover, the spread of the crisis across countries seems to have been channelled more by financial linkages than conventional trade linkages. This raises questions about the future of financial integration among Asian economies and between Asia and the rest of the world. This paper first documents some features of the propagation of the global financial crisis. It then goes on to explore a two-country theoretical model in which there is a trade-off between the risk sharing benefits of international financial markets and the contagion effects of international financial interdependence. The key resultfeature of the model is to show that financial market integration in the presence of financial constraints can generate very high macroeconomic comovement among economies, quite independent of international trade linkages.

link to paper not available.

The macroeconomic response to the economic crisis has revived old debates about the usefulness of monetary and fiscal policy in fighting recessions. Without the ability to further lower interest rates, policy authorities in many countries have turned to expansionary fiscal policies. Recent literature argues that government spending may be very effective in such environments. But a critical element of the stimulus packages in all countries was the use of deficit financing and tax reductions. This paper explores the role of government debt and deficits in an economy constrained by the zero bound on nominal interest rates. Given that the liquidity trap is generated by a large increase in the desire to save on the part of the private sector, the wealth effects of government deficits can provide a critical macroeconomic response to this. Government spending financed by deficits may be far more expansionary than that financed by tax increases in such an environment. In a liquidity trap, tax cuts may be much more effective than during normal times. Finally, monetary policies aimed at directly increasing monetary aggregates may be effective, even if interest rates are unchanged.

[go to paper]


2010

This paper presents a general approximation method for characterizing timevarying equilibrium portfolios in a two-country dynamic general equilibrium model. The method can be easily adapted to most dynamic general equilibrium models, it applies to environments in which markets are complete or incomplete, and it can be used for models of any dimension. Moreover, the approximation provides simple, easily interpretable closed form solutions for the dynamics of equilibrium portfolios.

[go to paper]

The U.S. dollar is the central reference currency for international trade pricing and the main invoicing currency for primary commodities. This paper links these two observations within a stylized theoretical framework, and shows how to obtain a quantitative estimate of the gain to the U.S. economy when the dollar is a reference currency. With dollar invoicing of primary commodities, U.S. firms bear less exchange rate risk than foreign firms. This asymmetry leads to a dollar standard in international goods pricing. We then derive a simple analytical formula to calculate the gains and find that they are extremely small. Copyright (c) 2010 The Ohio State University.

[go to paper]

Recent macroeconomic experience has drawn attention to the importance of interdependence among countries through financial markets and institutions, independently of traditional trade linkages. This paper develops a model of the international transmission of shocks due to interdependent portfolio holdings among leverage-constrained investors. In our model, without leverage constraints on investment, financial integration itself has no implication for international macro co-movements. When leverage constraints bind however, the presence of these constraints in combination with diversified portfolios introduces a powerful financial transmission channel which results in a positive co-movement of production, independently of the size of international trade linkages. In addition, the paper shows that, with binding leverage constraints, the type of financial integration is critical for international co-movement. If international financial markets allow for trade only in non-contingent bonds, but not equities, then the international co-movement of shocks is negative. Thus, with leverage constraints, moving from bond trade to equity trade reverses the sign of the international transmission of shocks.

[go to paper]

The traditional current account can be an inaccurate measure of the change in the net foreign asset (NFA) position. Using gross asset and liability positions at the country level, a number of ‘valuation effects’ have been identified which contribute to changes in NFA but do not enter the reported current account. This paper uses new developments in the analysis of portfolio allocation in general equilibrium to investigate valuation effects in a two-country model. The model can be used to analyze both qualitatively and quantitatively the role of valuation effects. Broadly speaking, the valuation effects in the model correspond to those in the data, and have the effect of enhancing cross country risk sharing. But there is a key distinction between “unanticipated” and “anticipated” valuation effects. Unanticipated effects can be large, dominating the movement in NFA, but anticipated effects arise only at higher orders of approximation and are small for reasonable parameterisations. The paper also analyses the determinants of international portfolio positions, and their role in generating valuation effects from asset price and terms of trade changes.

[go to paper]

This paper develops a simple theoretical model that can be used to account for the determinants of exchange rate pass-through to consumer prices. While recent evidence has found low estimates of pass-through in many countries, there is little consensus on an explanation for this. Our paper argues that sticky prices represent a key determinant of exchange rate pass-through. We make this argument in two stages. First, holding the frequency of price change constant, we show that our model calibrated to data from low-inflation countries can reproduce the estimates of very low pass-through for these countries. The principal determinant of low pass-through in this case is the slow adjustment of prices. We then extend the model to allow the frequency of price change to be endogenous. Calibrating to a wider set of countries, including both low-inflation and high-inflation countries, we show that our model implies that exchange rate pass-through is increasing in average inflation, but at a declining rate. Performing the identical exercise on the data, we find a striking correspondence between the predictions of the model and those of the data.

[go to paper]


2009

Between 2002 and 2008, the Canadian dollar appreciated in real terms against the US dollar by 60 percent. This large change in real exchange rates between such major trading partners as Canada and the US is almost unprecedented. This paper explores the historical background to the movement of the Canadian dollar during this period, discusses the most accepted explanations for the appreciation, and speculates on the implications for the Canadian economy. The discussion is placed within the framework of recent developments in the theoretical and empirical literature on exchange rates.

[go to paper]

Since the crises of the late 1990′s, most emerging market economies have built up substantial positive holdings of US dollar treasury bills, while at the same time experiencing a boom in FDI capital inflows. This paper develops a DSGE model of the interaction between an emerging market economy and an advanced economy which incorporates two-way capital flows between the economies. The novel aspect of the paper is to make use of new methods for analyzing portfolio choice in DSGE models. We compare a range of alternative financial market structures, in each case computing equilibrium portfolios. We find that an asymmetric configuration where the emerging economy holds nominal bonds and issues claims on capital (FDI) can achieve a considerable degree of international risk-sharing. This risk-sharing can be enhanced by a more stable monetary policy in the advanced economy.

[go to paper]

Many emerging market economies have experienced large buildups of foreign exchange rate reserves over the last decade. Much of the contemporary discussion of this phenomenon has focused on this reserve growth as the consequence of exchange rate policies which have maintained fixed pegs to the US dollar. By contrast, this paper focuses on emerging market reserve choice as a consequence of portfolio diversification, applied to the experience of Asian economies. While Asian economies have become significant gross creditors in bonds and other fixed income assets, their liability position in equity and FDI assets has also grown significantly. This suggests that a full understanding of the reserve growth episode must be seen as part of an overall model of portfolio choice. The paper constructs a model of the interaction between an emerging market and an advanced economy in which an optimal general equilibrium portfolio structure implies that emerging market economies simultaneously build up a stock of foreign exchange rate reserves while receiving FDI flows from the advanced economy. The model can provide a reasonable quantitative account of the recent Asian experience.

[go to paper]

This paper develops an intermediate framework between models of fixed prices and models of state-dependent pricing. In this model, firms can choose in advance whether to have flexible prices. By incurring a fixed cost, a firm can invest in flexibility. If the firm incurs this fixed cost, then it can adjust prices ex post in the face of shocks to its demand or marginal cost. If it chooses not to incur this cost, it must set its price in advance. By assuming that firms face differential fixed costs of price flexibility, we can integrate this framework into a general equilibrium model of a small open economy and investigate the determinants of equilibrium price flexibility. In particular, we focus on the relationship between price flexibility and exchange rate policy.

[go to paper]


2008

What does financial globalization imply for the design of monetary policy? Does the case for price stability change in an environment of large cross country gross asset holdings?. This paper is concerned with the effects of monetary policy under endogenous international portfolio choice and incomplete markets. With endogenous portfolios, monetary policy takes on new importance due to its impact on the distribution of returns on nominal assets. Surprisingly, we find an even stronger case for price stability in this environment. Even without nominal rigidities, price stability has a welfare benefit by enhancing the risk sharing capacity of nominal bond returns.

[go to paper]


2007

Although emerging market Asian economies have experienced high growth without crises for close to a decade, many commentators find the large buildup of foreign exchange reserves among these economies both puzzling and evidence of incipient global imbalances. This paper reviews some of the experience of Asian countries over the last decade. We focus on the degree to which Asian economies have experienced financial globalization, meaning that their gross external asset and liability positions have grown significantly. In particular, while Asian economies have become significant gross creditors in bonds and other fixed income assets, their liability position in equity and FDI assets has also grown significantly. We show that a simple dynamic general equilibrium model of portfolio choice in an emerging market economy can account for this trend remarkably well.

[go to paper]

We study the classic transfer problem using the largest historical example, the Franco-Prussian War indemnity of 1871–1873 which saw France transfer to Germany 25% of a year’s GDP. A dynamic, two-country model allows for debt finance, supply-side effects, and controls for wartime spending. The model can fit the historical paths of French net exports and the terms of trade. But explaining French output and consumption requires additional shocks. These results illustrate the usefulness of the DSGE approach to the transfer problem and provide striking evidence of the importance of international capital markets in the 19th century.

[go to paper]

This paper develops a view of exchange rate policy as a trade-off between the desire to smooth fluctuations in real exchange rates so as to reduce distortions in consumption allocations, and the need to allow flexibility in the nominal exchange rate so as to facilitate terms of trade adjustment. We show that optimal nominal exchange rate volatility will reflect these competing objectives. The key determinants of how much the exchange rate should respond to shocks will depend on the extent and source of price stickiness, the elasticity of substitution between home and foreign goods, and the amount of home bias in production. Quantitatively, we find the optimal exchange rate volatility should be significantly less than would be inferred based solely on terms of trade considerations. Moreover, we find that the relationship between price stickiness and optimal exchange rate volatility may be non-monotonic.

[go to paper]

This paper explores the role of monetary policy in an open economy in an environment of endogenous portfolio choice. The model is simple enough to allow solutions for optimal portfolios to be derived analytically for a range of different asset market environments. We explore the impact of monetary policy on national bond and equity portfolios in environments where assets markets areeither complete or incomplete. (JEL: E52, E58, F41) (c) 2007 by the European Economic Association.

[go to paper]

A central aspect of the recent debate on global imbalances and the US current account deficit is the role of the exchange rate peg being followed by China and other Asian economies. While one view has stressed the need for Asian currency appreciation, another focuses on the importance of fiscal adjustment and more generally adjustment in relative savings rates in the US and Asian economies. This paper develops a simple two-region open economy macroeconomic model to analyze the alternative impacts of currency appreciation and fiscal adjustment on the current account. We stress a number of structural features of emerging Asian economies that may make currency appreciation an ineffective means of current account adjustment relative to fiscal policy changes. In addition, we note that there may be a welfare conflict between regions on the best way to achieve adjustment.

[go to paper]

We present a tractable, dynamic general equilibrium model of state-dependent pricing and study the response of output and prices to monetary policy shocks. We find important nonlinearities in these responses. For empirically relevant shocks, this generates substantially different predictions from time-dependent pricing. We also find a distinct asymmetry with state-dependent pricing: Prices respond more to positive shocks than they do to negative shocks. This is due to a strategic linkage between firms in the incentive for price adjustment. Our state-dependent model can account for business cycle asymmetries in output of the magnitude found in empirical studies. Copyright 2007 by the Economics Department Of The University Of Pennsylvania And Osaka University Institute Of Social And Economic Research Association.

[go to paper]

For the past four or five decades, the international monetary system has operated on a “dollar standard”. Popular discussion suggests that this gives the US an advantage in the use of monetary policy. This Paper analyses the determination of monetary policy in a world with a dollar standard, defined here as a environment in which all traded goods prices are set in US dollars. This generates an asymmetry whereby exchange rate pass-through into the US CPI is zero, while pass-through to other countries will be positive. We show that monetary policy in such a setting does seem to accord with popular discussion. In particular, the US is essentially indifferent to exchange rate volatility in setting monetary policy, while the rest of the world places a high weight on exchange rate volatility. More importantly, in a Nash equilibrium of the monetary policy game between the US and the rest of the world, the preferences of the US dominate. That is, the equilibrium is identical to one where the US alone chooses world monetary policy. Despite this, we find surprisingly that the US loses from the dollar’s role as an international currency. Even though US preferences dominate world monetary policy, the absence of exchange rate pass-through means that US consumers are worse off than those in the rest of the world, where exchange rate pass-through operates efficiently. Finally, we derive the conditions for a dollar standard to exist.

[go to paper]


2006

This paper empirically explores how fiscal policy (represented by increases in government spending) has asymmetric effects on economic activity at different levels of real interest rates. It suggests that the effect of fiscal policy depends on the level of real rates, since the Ricardian effect is smaller at lower financing costs of fiscal policy. Using threshold regression models on U.S. data, the paper provides new evidence that expansionary government spending is more conducive to short-run growth when real rates are low. It also finds asymmetric effects on interest rates and inflation, and threshold effects associated with substitution between financing methods.

[go to paper]

This paper provides a quantitative investigation of the East Asian crisis of 1997–1999. We stress two essential features of the crisis. First, the crisis was a regional phenomenon; the depth and severity of the crisis were exacerbated by a large decline in regional demand. Second, the predominance of the US dollar in the pricing of export goods in Asia (which we document empirically) led to a powerful internal propagation effect of the crisis within the region, contributing greatly to the decline in regional trade flows. We construct a multi-country macroeconomic model which contains these two features and show that it can do a good job in accounting for the response of the main macroeconomic aggregates in Korea, Malaysia and Thailand during the crisis. A key advantage of our model is that it can explain the very slow response of exports to the large real exchange rate depreciations that took place during the crisis. Without the regional dimension and dollar pricing of exports, we find that the model fails to account for the depth and severity of the crisis.

[go to paper]

Ireland is distinguished by the high degree of openness of its labour market and the importance of foreign direct investment (FDI) in the economy. We develop a neo-classical growth model to explore the consequence of these characteristics for the response of an economy to the kinds of shocks that are widely recognised to have been of importance in driving the Irish boom.

[go to paper]

Most theoretical analysis of flexible vs.fixed exchange rates takes the degree of nominal rigidity to be independent of the exchange rate regime choice itself. But informal policy discussion often suggests that a credible exchange rate peg may increase internal price flexibility. This paper explores the relationship between exchange rate policy and price flexibility, in a model where price flexibility itself is an endogenous choice of profit-maximizing firms. A fixed exchange rate can affect the optimal degree of price flexibility by altering the volatility of nominal demand facing price-setting firms. We find that a unilateral peg, such as a Currency Board, adopted by a single country, will increase internal price flexibility, perhaps by a large amount. On the other hand, when an exchange rate peg is supported by bilateral participation of all monetary authorities such as in a Monetary Union, price flexibility may actually be less than under freely floating exchange rates. Quantitatively, we find that the endogenous increase in price flexibility following a unilateral peg might be big enough that output volatility is no greater than it would be under a floating exchange rate regime.

[go to paper]

Many writers have argued for the benefits of a credible fixed exchange rate (a hard peg) as a commitment device in an open economy. But historically, fixed exchange rates have often been associated with large current account deficits and episodes of ‘over-borrowing’. This paper develops a model of capital inflows that are linked to the exchange rate regime because of endogenous fiscal policy. The key message of the paper is that a hard peg is undesirable in the absence of commitment in fiscal policy. In face of a credible fixed exchange rate, the fiscal authority subsidizes capital inflows. The economy will engage in inefficiently high international borrowing, and in welfare terms may end up worse off than under capital market autarky. To eliminate the incentive to subsidize borrowing, the monetary authority must follow a flexible exchange rate rule in which capital inflows lead to exchange rate appreciation. If fiscal policy must be financed by money creation rather than direct taxation, then a fixed exchange rate rule may cause both over-borrowing and a subsequent exchange rate crisis.

[go to paper]

We develop a general equilibrium monetary model of endogenous specialization and international trade to examine the degree of specialization and trade volume under alternative exchange rate regimes. Where demand shocks are important, we demonstrate an increase in specialization, trade and welfare under coordinated fixed exchange rates, equivalent to a common currency, relative to flexible exchange rates. Where supply shocks are important, the effects on specialization and trade are smaller and ambiguous in direction, though the welfare effects are comparable to those for demand shocks.

[go to paper]

We compare alternative monetary policies for an emerging market economy that experiences external shocks to interest rates and the terms of trade. Financial frictions magnify volatility but do not affect the ranking of alternative policy rules. In contrast, the degree of exchange rate pass-through is critical for the assessment of monetary rules. With high pass-through, stabilising the exchange rate involves a trade-off between real stability and inflation stability and the best monetary policy rule is to stabilise non-traded goods prices. With delayed pass-through, the trade-off disappears and the best monetary policy rule is CPI price stability.

[go to paper]

To what degree can the qualitative and quantitative aspects of the East Asian crisis be accounted for within a dynamic general equilibrium model? This paper investigates that question using a framework in which the crisis itself is modeled as an exogenous shock to the country risk premium. This exercise has empirical discipline because the scale of the shock can be measured by the movement in the reported risk premium. We calibrate a quantitative sticky-price dynamic general equilibrium model of a small open economy to match the features of three East Asian economies: Thailand, Korea, and Malaysia. We identify a shock to the country risk premium using published data from international bond markets, and identify short-run monetary policy using observed domestic interest rates. We find that the modeled response to the observed increase in external interest rates substantially matches macroeconomic data on prices and quantities at the aggregate and sectoral level. However, the model has more difficulty explaining the large exchange rate devaluations that occurred in those economies.

[go to paper]


2005

When the currency of export pricing is endogenous, there is a social benefit to exchange rate volatility that may be ignored by monetary authorities. As a result there is a welfare inferior equilibrium with zero exchange rate pass-through, and fixed exchange rates. This paper shows that there is a simple method of ruling out this equilibrium; restrict monetary authorities to respond only to domestic economic conditions.

[go to paper]

 

 

[Back to top]


OLDER PUBLICATIONS

2004 

Monetary Policy Rules and Exchange Rate Flexibility in a Simple Dynamic General Equilibrium Model.
Journal of Macroeconomics, 26, 287-308.

Endogenous Pass-through when Nominal Prices are set in Advance.
(with Charles Engel and Peter Storgaard)
Journal of International Economics, 63, 263-91.

Should the Exchange Rate be a Shock Absorber?
Journal of International Economics, 62, 359-77.


2003 

A Macroeconomic Analysis of EU Accession under Alternative Monetary Policies.
Journal of Common Market Studies, 41, 941-64.

Price Setting and Exchange Rate Pass-through: Theory and Evidence.
Price Adjustment and Monetary Policy, Bank of Canada.

Monetary Policy in the Open Economy Revisited: Price Setting and Exchange Rate Flexibility
(with Charles Engel)
Review of Economic Studies, 70, 765-84.

Mundell Revisited: A Simple Approach to the Costs and Bene ts of a Single Currency Area.
(with Stephen Ching)
Review of International Economics, 11, 674-91.

Exchange Rate Pass-through and the Welfare E ects of the Euro.
(with Charles Engel and Cedric Tille)
International Economic Review, 44, 223-242.

Understanding Bilateral Exchange Rate Volatility.
(with Philip Lane)
Journal of International Economics, 60, 109-132.

Predetermined Prices and the Persistent E ects of Money on Output.
(with James Yetman)
Journal of Money Credit and Banking, 35, 729-742.

A Tale of Two Currencies: The Asian Crisis and the Exchange Rate Regimes of Hong Kong and Singapore.
Review of International Economics, 11, 38-54.

Expansionary Fiscal Contractions: A Theoretical Exploration.
(with Frank Barry)
Journal of Macroeconomics, 25, 1-23.


2002

Menu Costs and the Trade-o between Inflation and Output.
(with James Yetman)
Economics Letters, 76, 95-100.

Exchange Rate Volatility, Exchange Rate Pass-through, and Exchange Rate Disconnect.
(with Charles Engel)
Journal of Monetary Economics, 49, 913-40.

Capital Controls in Malaysia: Eff ectiveness and Side E ffects.
(with David Cook)
Asian Economic Papers, 1 49-82.


2001

The Optimal Choice of Exchange Rate Regime: Price Setting Rules and Internationalized Production.
(with Charles Engel)
Topics in Empirical International Economics: Festschrift in Honor of Robert Lipsey, Magnus Blomstrom and Linda Goldberg, eds, NBER Press.

Monetary Policy, Exchange Rate Flexibility, and Exchange Rate Pass-through.
in Revisiting the Case for Flexible Exchange Rates, Bank of Canada.

Dynamic Gains from Trade with Imperfect Competition and Market Power.
(with Khang Min Lee)
Review of Development Economics, 5, 239-255.

The New International Macroeconomics: Some Policy Implications.
Economic Papers, 20, S1, 30-41.

The International Monetary Transmission of Monetary and Fiscal Policies in a Two Country Model.
(with Caroline Betts)
in Essays in Honor of Robert A. Mundell, M. Obstfeld and G. Calvo, eds, MIT Press.


2000

Government Spending and Welfare with Increasing Returns to Specialization.
(with Allen Head and Beverly Lapham)
Scandinavian Journal of Economics, 102(4), 547-561.

How Does a Devaluation a ect the Current Account?
Journal of International Money and Finance, 19, 833-851.

International Monetary Coordination and Competitive Depreciation: A Re-Evaluation.
(with Caroline Betts)
Journal of Money Credit and Banking, 32, 722-746.

Exchange Rate Dynamics in a Model of Pricing to Market.
(with Caroline Betts)
Journal of International Economics, 50, 1, 215-244.

Real Exchange Rates and Growth: A Model of East Asia.
Review of International Economics, 7, 509-521.


1999

Growth and the Dynamics of Endogenous Trade Liberalization.
Journal of Economic Dynamics and Control, 23, 773-795.

Endogenous Trade Policy and the Gains from International Financial Markets.
(with Khang Min Lee)
Journal of Monetary Economics, 43, 35-59.


1998

Political Instability, Capital Taxation, and Growth.
(with Jean Francois Wen)
European Economic Review, 42, 1635-51.


1997

The Real Exchange Rate and Macroeconomics: Evidence and Theory.
Canadian Journal of Economics, 30, 25-48.

Growth, Specialization, and Trade Liberalization.
International Economic Review, 38, 565-86.

Growth and Risk-Sharing with Incomplete International Assets Markets.
(with Makoto Saito)
Journal of International Economics, 42, 453-81.


1996

The Exchange Rate in a Model of Pricing to Market.
(with Caroline Betts)
European Economic Review, 40, 1007-1021.

Monopolistic Competition, Increasing Returns, and the E ects of Government Spending.
(with Beverly Lapham and Allen Head)
Journal of Money Credit and Banking, 28, 233-254.

Aggregate Fluctuations with Increasing Returns to Specialization and Scale.
(with Allen Head and Beverly Lapham)
Journal of Economic Dynamics and Control, 20, 627-656.


1995

Money and the Real Exchange Rate with Sticky Prices and Increasing Returns.
(with Paul Beaudry)
Carnegie Rochester Conference Series on Public Policy, 43, 55-102.

The `Expansionary Fiscal Contraction’ Hypothesis: A Neo-Keynesian Analysis.
(with Frank Barry)
Oxford Economic Papers, 47, 249-64.

Anticipated Budget De cits and the Real Exchange Rate.
Canadian Journal of Economics, November, 28, S207-S220.

The Dynamic E ffects of Government Spending Policies in a Two Sector Endogenous Growth Model.
(with David Love)
Journal of Money Credit and Banking, 27, 232-256.


1994

The Eff ects of Factor Taxation in a Two-Sector Model of Endogenous Growth.
(with David Love)
Canadian Journal of Economics, 27, 509-536.

International Risk-Sharing and Economic Growth.
(with Gregor Smith)
International Economic Review, 35, 535-50.

The Stability of Economic Integration and Endogenous Growth.
(with Beverly Lapham)
Quarterly Journal of Economics, 119, 299-305.


1993

Monopolistic Competition and Real Business Cycles.
(with Allen Head and Beverly C. Lapham)
Economics Letters 41, 57-61.

Government Spending and Crowding Out: A Review.
(with Frank Barry)
Economic and Social Review 23, 199-221.


1992

Does a Monetary Union Require International Fiscal Policy Coordination?
Economic and Social Review 23, 68-84.

International Fiscal Policy Coordination and Economic Growth.
(with Arman Mansoorian)
International Economic Review 32, 240-64.

Realistic Cross-Country Consumption Correlations in a Two-Country Real Business Cycle Model.
(with Allan Gregory and Gregor Smith)
Journal of International Money and Finance 11, 3-16.


1991

The Trade-Off Between Precommitment and Flexibility in Trade Union Wage Setting.
(with S. Anderson)
Oxford Economic Papers, 43.

The International Coordination of Fiscal Policies and the Terms of Trade.
Economic Inquiry 29, 720-36.

Government Purchases and Real Interest Rates with Endogenous Time Preference.
Economics Letters 35, 131-36.

Trade Unions, Non-Binding Wage Agreements, and Capital Accumulation.
(with Ben Lockwood)
European Economic Review 35, 549-69.


1990

Capital Accumulation and the Current Account in a Two-Country Model.
(with Shouyong Shi)
Journal of International Economics, 30, 1-25.

Fiscal Policy and the Real Exchange Rate.
(with D.D. Purvis)
European Economic Review, 34, 1201-1212.

International Cooperation, Precommitment and Welfare.
International Economic Review, 31, 39-55.

International Coordination of Macroeconomic Policies.
(with Thomas Wilson)
Canadian Public Policy, 15 , Supplement 20-33.


1989

A Positive Theory of Inflation and Inflation Variance.
Economic Inquiry, 27, 105-116.


1988

Profi t Sharing and Optimal Labour Contracts.
(with Simon Anderson)
Canadian Journal of Economics, 22, 425-433.

The Optimal Mix of Wage Indexation and Foreign Exchange Market Intervention.
Journal of Money Credit and Banking, 20, 381-392.

Non-traded Goods and the International Transmission of Fiscal Policy.
Canadian Journal of Economics, 21, 265-278.

Trade Unions and the Choice of Capital Stock.
Co-authored with Simon Anderson,
Scandinavian Journal of Economics, 90, 27-44.

A Positive Theory of Fiscal Policy for Open Economies.
(with D.D. Purvis and D. Backus)
in J.A. Frenkel ed. International Aspects of Fiscal Policy, University of Chicago Press, 173-196.


1987

Fiscal Spending, the Terms of Trade and Real Interest Rates.
Journal of International Economics, 22, 219-235.

The E ffect of Monetary Variability on Welfare in a Simple Macroeconomic Model.
Journal of Monetary Economics, 19, 427-435.

Public Investment and International Policy Coordination.
Economics Letters 22, 299-302.

[Back to top]