Short-Run Independence of Monetary Policy under Pegged Exchange Rates and Effects of Money on Exchange Rates and Interest Rates

This paper examines the effects of money supply changes on exchange rates, interest rates, and production in an optimizing two-country model in which some sectors of the economy have predetermined nominal prices in the short run and other sectors have flexible prices. Money supply shocks have liquid...

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Bibliographic Details
Published in:Journal of money, credit and banking credit and banking, 1997-11, Vol.29 (4), p.783-806
Main Authors: Ohanian, Lee E., Stockman, Alan C.
Format: Article
Language:English
Subjects:
Analysis
Economic models
Economic theory
Equilibrium
Excess supply
Exchange rates
Foreign exchange
Foreign exchange rates
Gross national product
Homes
Inflation
Interest rates
Monetary policy
Monetary theory
Money
Money supply
Monopolistic competition
Nominal interest rates
Nominal prices
Policy making
Price flexibility
Prices
Production
Studies
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Summary:This paper examines the effects of money supply changes on exchange rates, interest rates, and production in an optimizing two-country model in which some sectors of the economy have predetermined nominal prices in the short run and other sectors have flexible prices. Money supply shocks have liquidity effects both within and across countries and induce a cross-country real interest differential. The model predicts that liquidity effects are highly nonlinear and are not likely to be captured well empirically by linear models, particularly those involving only a single country. A striking implication of the model is that countries have a significant degree of short-run independence of monetary policy even under pegged exchange rates.
ISSN:0022-2879
1538-4616
DOI:10.2307/2953667