Real Adjustment Processes under Floating Exchange Rates PDF
Preview Real Adjustment Processes under Floating Exchange Rates
Studies In International Economics and Institutions Editor Hans-Jiirgen Vosgerau Advisory Board John S. Chipman Elhanan Helpman Ronald W. Jones Murray C. Kemp Horst Siebert Studies in International Economics and Institutions H.-J. Vosgerau (Ed.), New Institutional Arrangements for the World Economy IX, 482 pages. 1989 M. Rauscher, OPEC and the Price of Petroleum XII, 206 pages. 1989 Franz Gehrels . Horst Herberg Helmut Schneider Hans-Jiirgen Vosgerau (Eds.) Real Adjustment Processes under Floating Exchange Rates With Contributions by K. Baumgarten, L. Bellmann, G. Dieckheuer, B. Eckwert, K. Enders, B. Gehrke, H. Herberg, H. Kuhn, U. Muller, H. Nodinger, K. Peschel, U. K. Schittko, M. Schmid, H. Schneider, T. Tivig, H.-J. Vosgerau, J. Wagner With 33 Figures Springer-Verlag Berlin Heidelberg New York London Paris Tokyo Hong Kong Barcelona Professor Dr. Franz Gehrels, Volkswirtschaftliches Institut der Universitat Munchen, LudwigstraBe 28, 0-8000 Munchen 22 Professor Dr. Horst Herberg, Institut fUr Theoretische Volkswirtschafts-, lehre der Universitat Kiel, OlshausenstraBe 40-60, 0-2300 Kiel 1 Professor Dr. Helmut Schneider, Wirtschaftswissenschaftliches Institut der Universitat Zurich, RamistraBe 71, CH-8006 Zurich . Professor Dr. Hans-Jurgen Vosgerau, Sprecher des Sonderforschungsbe reichs 178 "Internationalisierung der Wirtschaft", Fakultat fUr Wirt schaftswissenschaften und Statistik der Universitat Konstanz, Postfach 5560,0-7750 Konstanz 1 For the addresses of the authors please contact the editors. They will be glad to help you. ISBN-13:978-3-642-84200-9 e-ISBN-13:978-3-642-84198-9 DOT: 10 .1007/978-3 -642-84198-9 Library of Congress Cataloging-in-Publication Data Real adjustment proceses under floating exchange rates 1 Franz Gehrels ... let al.l (eds.) ; with contributions by K. Baumgarten ... let al.l. p. cm. --(Studies in international economics and institutions) Includes bibliographical references (p.). ISBN-I 3:978-3-642-84200-9 1. Foreign exchange. I. Gehrels, Franz, 1922- II. Baumgarten, K. (Klaus) III. Series. HG3821.R43 1989 332.4'56--dc20 This work is subject to copyright. All rights are reserved, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in other ways, and storage in data banks. Duplication of this publication or parts thereof is only permitted under the provisions of the German Copyright Law of September 9, 1965, in its version of June 24, 1985, and a copy right fee must always be paid. Violations fall under the prosecution act of the German Copyright Law. © Springer-Verlag Berlin· Heidelberg 1990 Softcover reprint of the hardcover 1st edition 1990 The use of registered names, trademarks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. 2142/7130-543210 Table of Contents Page I. INTRODUcrION Helmut Schneider 1 II. CONTRIBUTIONS 20 1. Sectoral Effects of Higher Costs of Klaus Baumgarten 20 Imported Inputs Horst Herberg 2. The Dutch Disease or Problems of Klaus Enders 33 a Sectoral Boom 3. Sectoral Transmission and Aggregate Gustav Dieckheuer 53 Effects of Imported Inflation: An Ulrich Muller Econometric Input-Ou~ut Model for Helmut NOdinger the Federal Republic 0 Germany 4. Structural Change, Adjustment Strategies Joachim Wagner 81 and Employment in an Open Economy: Lutz Bellmann The Case of the Manufacturing Industries in the Federal Republic of Germany 5. Entrepreneurial Adjustm.ent in Structural Birgit Gehrke 99 Change -Results from a Survey of Selected Lower Saxonian Industries, 1980-1985 6. Non-Tariff Barriers to Trade -Unsuitable Horst Herberg 113 Instruments of an Employment Policy HannoKiihn 7. On the Spatial Structure of the World Karin Peschel 129 Economy Since World War II 8. The Extended Moving-Equilibrium Thusnelda Tivig 158 Method: A Presentation 9. Local Stability and Dynamic Aspects in mrich K Schittko- 169 a Two-Country Model with Fixed and Bernhard Eckwert Flexible Exchange Rates 10. Alternative Specifications of Asset Thusnelda Tivig 204 Markets in Portfolio Balance Models 11. On Fiscal PONZI Games in a World Michael Schmid 242 with Overlapping Generations III. APPENDIX 291 1. The Research Programme "Inflation and Hans-Jurgen Vosgerau 291 Employment in Open Economies" 2. Projects 292 3. Publications 295 I. Introduction Helmut Schneider 1. The Formulation of the Research Programme 1. In the late sixties the acceleration of US inflation revived the discussion of the fifties about the superiority of flexible exchange rates: The US balance of payments deteriorated since 1965, the dollar shortage after World War II changed to a dollar surplus. The import of US inflation by their main trading partners intensified political pressures so that at the beginning of the seventies most leading countries decided, contrary to the rules of the Bretton Woods agreement, to stop their intervention in the market for foreign exchange and to let the exchange rates be determined by market forces. It is worthwhile recalling that at that time one had only very limited experience with the regime of flexible exchange rates: The most important case, the floating of Canadian against the US dollar, could not be generalized to a world where nearly all important countries adhered to the regime of flexible exchange rates.! -But one really had rich experience with destabilizing capital flows (or "hot money") that forced monetary authorities to adjust exchange rates in a system of managed flexibility to the expecta tions of "speculators". If speculative flows would continue in a system of flexible exchange rates, should we expect exchange rates to fluctuate boundlessly? Or were these flows only the consequence of the artificial determination of exchange rates by the intervention of monetary authorities in the markets for foreign exchange? In the beginning of the seventies some critical experts remained convinced of the destabilizing character of international capital flows. They expected the standard deviation of exchange rates to rise substantially and the international monetary system therefore to be unable to sustain an orderly international payments system: The gains from the international division of labour that were obtained only recently and partially 1 Cf. E. Sohmen (1961), Flexible Exchange Rates, Chicago (2nd edition 1969). Studies in International Economics and Institutions F. Gehrels, H. Herberg, H. Schneider, H.-J. Vosgerau (Eds.) Real Adjustment Processes Under Floating Exchange Rates © 1990 Springer-Verlag Berl in Heidelberg 2 after World War II would be destroyed once more. On the other hand, in the period from 1965 to 1973 monetary authorities experienced their unability to influence domestic money supply and prices. Their interventions in the market for foreign exchange foiled all attempts to control domestic inflation. It was clear that in order to restore the effectiveness of national monetary policy the introduc tion of a regime of flexible exchange rates would be necessary. But would flexible ex change rates really insulate the domestic economy from all foreign disturbances? Even at the price of a deterioration of international division of labour? 2. In 1978 the German Science Foundation started a Special Research Programme on "Inflation and Employment in Open Economies",2 that lasted to the end of 1987. The main objectives of this research programme were formulated by a group of the German Economic Association3 in 1976. The main questions suggested by this group were: (1) In constructing a model one has to select some markets to be represented within the model while others have to remain outside (partially due to Walras' law). What are the characteristics of these markets to be modelled explicitly? (2) In these models what is the role of private wealth? And that of its structure, i.e. the relation of financial to real wealth? (3) What are the effects of fiscal policy in an open economy, and how do they depend on the financing of public expenditure? (4) It is known from trade theory that some of the main results not only crucially depend on the distinction between tradable and non-tradable goods but also that the bulk of international trade is in intermediate goods with consumption goods playing only a minor role. What are the implications of non-tradables and of intermediate goods for (macroeconomic) models of inflation and employment? 2 Schwerpunktprogramm "Inflation und Beschaftigung in offenen Volkswirtschaf ten" der Deutschen Forschungsgemeinschaft 3 Ausschuss fiir Aussenwirtschaftstheorie und -politik der Gesellschaft flir Wirt schafts- und Sozialwissenschaften (Verein flir Socialpolitik) 3 (5) The international dependence of a country is determined not only by commodity trade but also by flows of financial and real capital, by labour migration and (real) capital, by the international price and wage structure, and by barriers to trade. How are these aspects to be incorporated to a (macroeconomic) model for an open economy? (6) What are the interactions between stocks of foreign assets and international flows of capital and their implications for a portfolio theory of international capital flows? (7) A two-country-model not only exaggerates the interdependence of the two coun tries e.g. with respect to their national economic policies, it is also inappropriate to study phenomena such as Euro-markets, trade agreements or custom unions. What can be learned from models with at least three countries? There was no thorough coordination of the studies promoted in this programme - except by the discussions at two conferences regularly held in spring and autumn of each year.4 The papers published below will give some impression of the research and the results of this programme even if they are not representative as they concentrate on results obtained in the last years and there was no selection process by the editors. With two exceptions they are published here for the frrst time in English. 2. An Introduction to the Contributed Papers 3. From the beginning of this research programme it was well understood that the incorporation of flexible exchange rates in a (macroeconomic) model of income and employment presupposes some combination of nominal and real variables as a free market for foreign exchange will automatically balance the value of exports and imports and capital flows. A fIrst group of studies started with the famous result of Laursen and Me tzler5 who formulated - to recall it - their model exclusively in nominal terms. As they assume 4 Cf. section 1 of the appendix below. 5 Cf. Laursen and Metzler (1950), Flexible Exchange Rates and the Theory of Employment, Review of Economics and Statistics 32, 281-299. 4 capital flows to be marginal (because of the very restrictive capital controls in the early 50's), nominal national income (Y) equals nominal domestic absorption (A) 6 Y=C+I=A (1) Under a regime of flexible exchange rates domestic money supply 7 is controlled by the domestic monetary authorities. Therefore the only way external shoeks may influence the domestic economy is by a variation of the terms of trade or relative prices 1t, i.e. domestic absorption is related to nominal income and the terms of trade by some func tion A = A(Y,1t) 8 (2) 4. Obviously capital flows played a substantial role in the 60's and the 70's: The insta bility they created was the main reason for the installation of a regime of flexible exchange rates. Supposing that the market for foreign exchange will equilibrate instan taneously, (1) is modified to 6 In the following, nominal variables will be denominated by capital letters, real variables by lower-case ones. 7 If the income velocity of money really would be an exogeneous variable and domestic production could be derived from the equilibrium on the factor markets, the domestic price level could be determined by the quantity of money, the exchange rate by the purchasing power theory. There are some papers using these lines of research, cf. e. g. Furstenberg, R. (1985), On Monetary Causes of Real Exchange Rate Changes, Kieler Studien Nr. 196, Mohr-Siebeck, Tubingen. This strategy is bound to fail if a significant part of the domestic quantity of money H is not held for transaction purposes only, if it varies in time and - still worse -if it depends on endogenous variables. In the Keynesian tradition this is expressed by the influence of the interest rate r on the cash holdings for speculative purposes: The equilibrium in the money market is determined by L(Y,r) =H or -after division of both sides by the price level1t - L(y,r) = Hl1t =: h h : real quantity of money 8 Cf. Laursen & Metzler, loe.cit. 5 Y = A + (X-M) = A + Kex (3) where (X-M) is the trade balance and Kex denotes net capital exports of the domestic economy. In order to close the model one has to add some assumption either on the propensity to spend domestic income on imported goods or on the determination of capital flows (cf. contributions 1-3 below). But in the decade after 1975 Western industrial economies suffered high and persisting unemployment, economists were interested in unemployment and their remedies. One way to combine the ideas of Laursen and Metzler with the actual problems seemed to be the deflation of (3) by the domestic price level and thus defining real exports and real imports: y =a + (x-m) (4) The first group of studies in the research programme therefore took (4) as a starting point.9 They have to determine domestic (real) production y, domestic demand for home and foreign goods (= real absorption a), foreign demand for home goods (= exports x) home demand for foreign goods (=imports m). 5. For the determination of domestic demand for goods one gets e.g. the following model: 10 y=ah+ x (5) ah = a(y,r,k,7t/e7t*) 9 Cf. J. Roth, Lohnpolitik im makrookonomischen Systemzusammenhang einer offenen Wirtschaft, Beitrag zur Arbeitskonferenz im Schwerpunktprogramm "Inflation und Arbeitslosigkeit in offenen Volkswirtschaften" der DFG vom 22. bis 25.6.1980 in Ermatingen, S. 24. 10 This IS-LM model is to be found e.g. in 1. Roth, loc.cit., Hessel, M. and R. Witzel (1979), Ein Ungleichgewichtsmodell einer offenen Volkswirtschaft mit flexiblen Wechselkursen, Diskussionsbeitrag Schwetzingen 1979; Herberg, H. (1979), Stagflation and Expansionary Economic Policies under Flexible Exchange Rates, Economic Letters 2, 181-185.
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