国际货币与金融经济学09

Chapter9:

Monetaryand Portfolio Approaches to Exchange-Rate and Balance-of-PaymentsDetermination

I. Chapter Overview

Chapter9 is devoted to explaining the monetary and portfolio approaches toexchange-rate and balance-of-payments determination. The chapterbegins with a discussion of central banks' balance sheets, and thenfollows with a description of the way in which central bankoperations can affect the national stock of money via the moneymultiplier effect. The second section explains how foreign currencyoperations of the central bank impact the domestic money stock. Itthen addresses how central banks can affect the exchange rate of itscurrency by leaning with or against the wind. The section nextdistinguishes between sterilized and unsterilized interventions. Examples are given for a simplified balance sheet of the U.S. FederalReserve Bank and the Bank of Japan.

Thethird section of the chapter presents the monetary approach,beginning with the Cambridge equation for money demand based on thetransactions demand for money. Absolute purchasing power parity andthe balance of payments accounting identity are

conditionis in turn used to study the consequence of changes in money demandon the balance of payments under both fixed and flexible exchangerates. The next section
thenused to derive the international monetary equilibrium condition. Theequilibrium

identityfor the household's allocation of wealth among both monetary andnon-monetary

financialinstruments. The chapter ends with a discussion of whether or notforeign exchange rate interventions should be sterilized. Accordingto the monetary approach, such sterilization will be ineffective,since it does not alter the total stock of money. By contrast, theportfolio approach predicts that sterilization has the potential tobe effective, since it will alter the relative holdings of domesticand foreign bonds.

II. Outline

A.Central Bank Balance Sheets
1.A Nation's Monetary Base
2.Nation's Money Stock
a. AnOpen-Market Transaction
b.The Money Multiplier
3.The Relationship Between the Monetary Base and the Money Stock

b.Leaning With or Against the Wind
c. FinancingInterventions
2.Foreign Exchange Interventions and the Money Stock a. AnExample of a Foreign Exchange Transaction b.The Effect on the U.S. Money Stock
3.Sterilization of Interventions

C.The Monetary Approach to Balance-of-Payments and Exchange-RateDetermination 1.The Cambridge Approach to Money Demand
2.Money, the Balance of Payments, and the Exchange Rate
a. TheRelationship between the Money Stock and the Balance of Payments b.The Relationship between Domestic Prices, Foreign Prices, and theSpot ExchangeRate
TheMonetary Equilibrium Condition c.

3.The Monetary Approach and a Fixed Exchange Rate Arrangement a. AChange in Domestic Credit
b.A Change in the Quantity of Money Demanded
4.The Monetary Approach and a Flexible Exchange-Rate Arrangement a. AChange in Domestic Credit
b.A Change in the Quantity of Money Demanded

D.Applying the Monetary Approach: A Two-Country Setting 1.A Two-Country Monetary Model 2.An Example of Exchange-Rate Determination for TwoNations
3.A Change in the Foreign Interest Rate
4.To Sterilize or Not to Sterilize?

SterilizedForeign Exchange Interventions and the Monetary Approach a.

b.Sterilized Foreign Exchange Interventions and the Portfolio Approach5. Do Interventions Accomplish Anything?

F.Chapter Summary

III. Fundamental Issues

1.What are the main assets and liabilities of central banks?

2.How do a central bank's foreign exchange market interventions alterthe monetary baseand the money stock?

3.What is the monetary approach to balance-of-payments andexchange-rate determination?

4.How is the monetary approach a theory of exchange rate determinationin a two- countrysetting?

5.What is the portfolio approach to exchange-rate determination?

6.Should central banks sterilize foreign exchange interventions?

IV. Chapter Features

1. Policy Notebook: "The Global Equities Explosion"

Thismanagement notebook considers the extremely rapid increase in globaltrade of equities. It also explains the downturn in the growth ofglobal equities that occurred in the early 2000s. Nonetheless, theseequity markets are having an increasingly large influence on foreignexchange values. Given expectations of equity markets growing fasterthan world output, the impact of equity markets on exchange values isexpected to increase.

ForCritical Analysis: The early 2000s was period of sluggish investmentspending and economic growth/activity for the advanced economies. Eventually, U.S. equity markets

noticeablewith renewed merger and acquisitions activity.

2.Online Notebook: “For foreign Securities Regulators, ‘Out ofSight’ Dosen’t Mean
beganto rally and corporate investment spending started to expand,particularly

wasin full compliance with regulations when it met all U.S. securitiesregulations.

Regulatorsin other nations, however, charged that it was not in compliance withtheir laws unless it established a physical presence in their county. Hence, Internet-based securities firms face a potential maze ofinternational regulations.

ForCritical Analysis: Of course the answer to this question depends onhow closely U.S. rules meet the objective of foreign regulators. Italso depends on the degree to which U.S. rules are enforced.

V. Answers to end of Chapter Questions

1.The balance sheet for the Bank of Japan would be similar to that ofthe Federal Reserve as shown in Figure 9-4. The change in foreignreserves and bank reserves is a decrease of ¥78,600,000. Thebalance sheet for Australia's central bank would show an increase inforeign reserves and bank reserves of A$1,000,000.

2.The money multiplier for Australia is 5, so the maximum change in themoney stock is A$5 million. The money multiplier for Japan is 12.5,so the maximum change in the money stock is ¥982.5 million.

3.Foreign exchange reserves fell by ¥78.6 million. The purchase ofdomestic securities increases domestic credit by ¥47.5 million. Hence, the change in the monetary base is -¥78.6 million + ¥47.5million = -¥31.1 million. The money multiplier is 12.5, so thedecrease in the money stock is -¥388.75 million.

4. The money multiplier in this example is 1/(rr + b). a. m= 1/.10 = 10.

b.m = 1/(.10 + .25) = 1/.35 =2.86.

5. Using the formula provided on page 307, m(DC + FER) = kSP*y.

a. Themoney stock is 2($1,000 + $80) = $2,160 million.

b.The level of real income is: [2($1,000 + $80)]/[(0.20)(1.2)(2)] =$4,500 million.

6. An open market purchase of securities in the amount of $10 million:
a. Afixed exchange rate regime requires a decrease in foreign reserves inan equal amount. Hence, this action results in a balance of payments deficit in theamount

b.A flexible exchange rate regime results in a new spot exchange rateof 2.019, whichis a depreciation of the domestic currency. This problem is solvedby using thevalue for real income derived in 5 b above: [(2($1,010 +
of$10 million.

3percent increase in the monetary base times the money multiplier.

b. Undera flexible exchange rate regime, the increase in New Zealand’smoney stockwould cause the exchange rate, S=0.9457 on page 313, to decline. This representsa depreciation of the New Zealand dollar.

8.The wealth identity is given on page 315 as W≡ M + B SB*. An openmarket sale of securitieswould reduce bank reserves, increasing the domestic interest rate.

Individualswould shift from foreign bonds to domestic bonds, leading to an
appreciationof the domestic currency. Under a fixed exchange rate, the openmarket sale would result in an improvement of the domestic nation’sbalance of payments.

(Theelasticity diagrams in Chapter 8 are useful in answering thisquestion.)

9.This answer is an illustration of problem 8 under flexible exchangerates. The open market sale would cause an increase in the demand forthe domestic currency and the domestic currency would appreciate as aresult.

10.The wealth identity is given on page 315 as W≡ M + B SB*. From theforeign nation

itis W ≡ M* + B* + (1/S)B. An open market sale of securities by theforeign central

bankwould reduce foreign bank reserves, increasing the foreign interestrate relative to the domestic interest rate. Individuals would shiftfrom domestic bonds to foreign bonds, leading to an depreciation ofthe domestic currency.

VI. Multiple Choice

1.Which of the following is not true about a nation's (simplified)monetary base?

A. It is controlled by the central bank.

B. It is the sum of domestic credit and foreign exchange reserves. C. It is the sum of foreign exchange reserves and total bank reserves.D. It is the sum of currency and total bank reserves.

Answer:C

2.The maximum change in total deposits that can result from an openmarket operation isthe change in:

A.total reserves divided by the reserve requirement. B. total reservesmultiplied by the reserve requirement.

D.nonborrowed reserves.

Answer: A C.excess reserves.

B. when savings equal investment.

C. if there are no foreign currency holdings.

D. if the monetary base is comprised solely of transactions deposits.

Answer: D

4.The transactions multiplier is equal to the:

A. inverse of the reserve requirement.

B. sum of the changes in the money supply in each round of spending.C. percentage of income spent on consumption.

D. percentage of income lost due to transaction costs.

Answer: A

5.One reason why the final multiplier is less than the amount given bythe money multiplieris that:

A. it takes an infinite amount of time to realize the full impact.

B. the assumption of a closed economy rarely holds. C. most peoplehold some money in the form of currency. D. seasonal effects alterthe size of the multiplier.

Answer: C

6.The method that the Fed often uses in order to offset a foreignexchange intervention is:

A. an adjustment of the reserve requirements.
B. an open-market transaction.

C. an adjustment to the discount rate.

D. to direct the Treasury to print more money.

Answer: B

7.Recent research has indicated that sterilized interventions:

A. have no bearing whatsoever on exchange rates.

C. can affect exchange rates by lowering the currency holdings of thecentral bank. D. do, at least temporarily, affect exchange ratesthrough a portfolio effect.
B. cannot be properly coordinated due to conflicting national policygoals.

A. Adam Smith.

B. David Ricardo.

C. Milton Friedman.
D. David Hume.

Answer: D

9.The equation relating money demand to a fraction of nominal GDP iscalled the:

A. Fisher equation.

B. absorption approach.
C. Cambridge equation.
D. elasticities approach.

Answer: C

A. purchasing power parity holds in the short run.

B. uncovered interest parity holds.

C. capital markets are dominated by the actions of a few centralbanks. D. purchasing power parity holds in the long run.

Answer: D

11.When the domestic price level is equal to the spot exchange ratetimes the foreign pricelevel then:

A. absolute purchasing power parity holds.

B. uncovered interest parity holds.

C. covered interest parity holds.

D. the central bank is forced to intervene in foreign exchangemarkets.

Answer: A

12.The underlying principle of the monetary approach is that balance ofpayments and spotexchange rates are influenced by:

A. speculation in the foreign exchange markets. B. any event thatcauses a difference between the quantity of money demanded and thequantity supplied.

13.Under a fixed exchange rate, the additional purchase of foreign goodswill generate a balanceof payments:

A. surplus with no change in the exchange rate.

B. deficit with no change in the exchange rate. C. deficit with anappreciation in the exchange rate. D. surplus with a depreciationin the exchange rate.

Answer: B

14.Under a flexible exchange rate, the additional purchase of foreigngoods will generate:

A. a depreciation of the domestic currency with a balance of paymentssurplus. B. an appreciation of the domestic currency with a balanceof payments deficits. C. an appreciation of the domestic currencywith no change in the balance of

payments.

D.a depreciation of the domestic currency with no change in the balanceof payments.

Answer: D

15.According to the monetary approach, under a fixed exchange rate, arise in the foreign pricelevel will result in a

A. balance of payments surplus.

B. balance of payments deficits.

C. devaluation of the domestic currency.

D. a balance of payments equilibrium

Answer:A

16.According to the monetary approach, under a fixed exchange rate, afall in domestic realincome will result in a:

A.balance of payments surplus.
B. balance of payments deficit.

D. revaluation of the domestic currency.

Answer: B C. devaluation of the domestic currency.

A. a current account deficit and no change in the value of thecurrency.
B. a current account surplus and no change in the value of thecurrency.
C. a depreciation of the domestic currency.

D. an appreciation of the domestic currency.

Answer: C

18.According to the monetary approach, the spot exchange rate isinversely related to eachof the following except the:

A. foreign money supply.

B. domestic marginal propensity to hold money.
C. domestic real GDP.

D. foreign real GDP.

Answer: D

19.According to the two-country version of the monetary approach, underflexible exchangerates, the spot exchange rate is determined by the:

A. currency board of the nation.

B. relative quantities of money supplied and demanded for the twocountries. C. ratios of foreign exchange held by the central banks.

D. activity related to the two currencies in question.

Answer: B

20.The portfolio approach expands on the monetary approach byrecognizing that householdsmay desire to:

A. hold more cash for transaction purposes.

B. alter their portfolios due to country risk.

C. alter their portfolios in response to the business cycle.

D. hold other financial instruments such as domestic and foreignsecurities.

Answer: D

wealthin:

A. money, domestic bonds, or foreign bonds.
21.The simple model of the portfolio approach assumes households chooseto hold their

Answer: A

22.The portfolio approach postulates that, under floating exchangerates, a decline in the domesticinterest rate results in:

A. a balance-of-payments surplus.

B. a balance-of-payments deficit.

C. a depreciation of the domestic currency.
D. an appreciation of the domestic currency.

Answer: C

23.The portfolio approach postulates that, under flexible exchangerates, an open market saleof securities by the domestic central bank will result in:

D. an appreciation of the domestic currency.

Answer: D

24.Regarding the issue of sterilization in foreign exchange markets, themonetary and portfolioapproaches:

A. offer similar theoretical results.

B. offer conflicting answers.

C. consider only fixed and flexible exchange rate systems,respectively. D. can be reconciled by considering both domestic andforeign policy actions.

Answer: B

25.According to the monetary approach, fully sterilized foreignintervention is:

A. ineffective.

B. extremely potent.

C. only somewhat potent.
D. impossible to carry out.

26.When a central bank intervenes in foreign exchange markets, it doesso using:: Answer: A
D. a combination of reserve requirement and discount rate adjustments.

Answer:C

27.A central bank sterilizes its foreign exchange interventions in orderto:

A.signal its future policy intentions.

B.expose counterfeit currencies.

C.retaliate against nations who have imposed trade restrictions.

D.prevent its foreign exchange interventions from influencing thedomestic money supply.

Answer:D