Polly Reynolds Allen

Fundamental Determinants of Exchange Rates

Existing models fail to explain the large fluctuations in the real exchange rates of most currencies over the past twenty years. The Natural Real Exchange Rate approach (NATREX) taken here offers an alternative paradigm to those which focus on short-run movements of nominal eschange rates, purchasing power parity of the representative agent intertemporal optimization models. Yet it is also neo-classical in its stress upon the accepted fundamentals driving a real economy. It concentrates on the real exchange rate, and explains medium- tolong-run movements in equilibrium real exchange rates in terms of fundamental variables: the productivity of capital and social (public plus private) thrift at home and abroad. The NATREX approach is a family of growth models, each tailored to the characteristics of the countries considered. The authors explain the real international value of the US dollar relativ to the G10 countries, and the US current account. These are two large economies. The model is also applied to small economies, where it explains the real value of the Australian dollar and the Latin American currencies relative to the US dollar. The model is relevant for developing countries where the foreign debt is a concern. Finally, it is applied to two medium-sized economies to explain the bilateral exchange rate between the French franc and the Deutsche Mark. The authors demonstrate both the promise of the NATREX model and its applicability to economies large and small. Alongside the analysis, econometrics, and technical details of these case studies, the introductory chapter explains in accessible terms the rationale behind the approach. The mix of theory and empirical evidence makes this book relevant to academics and advanced graduate students, and to central banks, ministries of finance, and those concerned with the foreign debt of developing countries.

Capital market integration

Abstract Liberalization in the EC in 1992 should produce perfect capital market integration. To show the short- and long-run effects of perfectly integrated capital markets, we develop a tractable growth model where investment flows to earn the highest rate of return. The economy first goes through potential, and then actual, integration, before and after rates of return are equalized. We show relative changes of capital intensities, outputs per capita, rates of return and the real exchange rate during both stages of integration.

The private ECU markets : What they are, why they exist, and where they may go

Abstract The private ECU has moved beyond a currency basket to function fully as a currency in the financial markets, with market-determined ECU interest rates and a market-determined exchange rate that the banks peg to the basket. A utility maximizing model is developed that explains the existence of the ECU financial markets, where demands for ECU-denominated financial instruments must depend on risk aversion and acquisition costs. Transactions demand for ECUs is based almost solely on ECU transactions in the financial markets. The ecus future as an independent currency with a floating exchange rate will require a central bank to control supply and an ECU money demand that is based on ECU transactions in goods and services.

Transactions Use of the Ecu in the Transition to EMU: A Model of Network Externalities

To answer the question under what conditions during the transition to EMU will firms choose the Ecu as their currency for transactions, the paper develops a simple model of a firms choice of currency for pricing, invoicing and receiving payments for its product-its transactions currency. The focus of the model is the presence of network externalities derived from use of the same currency by others. The model points up the fallacy of focusing only on relative inflation performances of currencies when judging their likely adoption for transactions purposes.