Download International Trade Policy: Issues and Analysis

Harvard University
John F Kennedy School of Government
Professor Andrés Velasco
Spring 2004 (updated April 29, 2004)
International Finance: Issues and Analysis
ITF-346
OVERVIEW
This is an advanced course on international finance and macroeconomics for students who have a
good background in micro and macroeconomic theory, econometrics, and mathematical techniques
for economic analysis (in particular multivariate calculus and static and dynamic optimization). The
objective of the course is to develop expertise with economic models used for the analysis of policy
issues in international finance and macroeconomics. The course relies on economic research to
develop a substantive understanding of policy issues as well as a facility with the models themselves.
Issues of interest to developing countries receive special attention.
The course is designed to appeal to two groups of students: MPAID and other Kennedy School
students with excellent backgrounds in micro and macroeconomics and quantitative methods, and
Ph.D. students (in economics, public policy, and PEG) with substantive interests in international
finance and macroeconomics.
READINGS
Readings are drawn from the current economics literature. They will be technical and
mathematically sophisticated, requiring close attention. Starred articles indicate required reading. No
single text is required for the course, but useful treatments of almost all the topics can be found in M.
Obstfeld and K. Rogoff (OR), Foundations of International Macroeconomics, 1996, the Handbook
of International Economics (GO), Vol. 3, G. Grossman and K. Rogoff (eds.), June 1995, and
Development Macroeconomics by Pierre Richard Agenor and Peter Montiel (AM), 2nd edition, 1999.
Classic if outdated general references are R. Dornbusch, Open Economy Macroeconomics (OEM),
Basic Books, 1980, and Handbook of International Economics (HIE) Vol. 2, R. Jones and P. Kenen
(eds), 1985. In addition to the readings, we will use handouts which lay out the basic theoretical
model for each section. These handouts will be at the center of class discussions, but they should not
be viewed as a substitute for reading the original articles.
PREREQUISITES
Macroeconomic theory at the intermediate level and multivariate calculus and dynamic optimization
(rudiments of control theory and dynamic programming) are necessary. Previous exposure to upper
level international finance is useful but not required. The course freely uses the techniques of
dynamic optimization in continues time. Some tips will be provided at the start. As background
reading I highly recommend a close reading of the math appendix of OR and of “Dynamic
Optimization in Continuous-Time Economic Models (A Guide for the Perplexed),” by Maurice
Obstfeld of Berkeley, at http://emlab.Berkeley.EDU/users/obstfeld/e202b/e202b.html.
GRADING
Grading will be based on a midterm to be administered in class (30%), 4 problem sets (30%), and a
final (40%). The midterm will take place early in March.
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COURSE CONTENTS
I. Basic Relationships (this section will not be discussed in class; you should review the materials
on your own)
Dornbusch, R. (1980) Open-Economy Macroeconomics, Ch. 1
Dornbusch, R. (1988) "Balance of Payments Issues" in Helmers, F.L. and R. Dornbusch (eds.) The
Open Economy: Tools for Policymakers in Developing Countries The World Band and Oxford
University Press, 1988.
II. Optimizing Models of the Current Account
1. The Open-Economy Ramsey Model
*Blanchard, O. and Fischer, S. (1989) Lectures in Macroeconomics, Chapter 2.
*Sachs, J. (1982) "The Curent Account in the Macroeconomic Adjustment Process" Scandinavian
Journal of Economics, Vol. 84, pp. 147-159.
OR, Chs. 1 and 2
Svensson, L. and A. Razin (1983) The Terms of Trade and the Current Account: The HarbergerLaursen-Metzler Effect" Journal of Political Economy, Vol 91, pp. 97-125.
Obstfeld, M. (1982) "Transitory Terms of Trade Shocks and the Current Account: The Case of
Constant Time Preference" NBER Working Paper No. 833.
_____________________ (1982) "Aggregate Spending and the Terms of Trade: Is there a LaursenMetzler Effect?" Quarterly Journal of Economics, Vol. 97.
_____________________ (1990) "Intertemporal Dependence, Impatience and Dynamics"
Journal of Monetary Economics, Vol 26.
2. Application: Temporary Policies and Intertemporal Distortions
*Calvo, G.A., "Costly Liberalizations," International Monetary Fund Staff Papers, Vol. 35
(September 1988), pp. 461-473..
Engel, C., and K.M. Kletzer, "Trade Policy under Endogenous Credibility," Journal of Development
Economics, Vol. 36 (1991), pp.213-228.
van Wijnbergen, S. "Trade Reform, Policy Uncertainty, and the Current Account: A
Non-Expected-Utility Approach" American Economic Review, Vol. 82 (1992), pp. 626-633.
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First problem set
III. Non-Traded Goods and the Real Exchange Rate
1. Traditional Models
Corden, M. (1960) "The Geometric Representation of Policies to Attain Internal and External
Balance" Review of Economic Studies, VOl. 28, pp. 1-22.
Salter, W. (1959) "Internal and External Balance: The Role of Price and Expenditure Effects"
Economic Record, Vol. 35, pp. 226-238.
Swan, T. (1960) "Economic Control in a Dependent Economy" Economic Record, Vol. 36, pp. 5166.
Dornbusch, R. (1980) Open-Economy Macroeconomics, Ch. 6.
____________ (1975) "Exchange Rates and Fiscal Policy in a Popular Model of International
Trade" American Economic Review, Vol. 65, pp. 859-871.
2. Dynamic Behavior
*AM, Ch. 7.
*Dornbusch, R. (1983) "Real Interest Rates, Home Goods and Optimal External Borrowing"
Journal of Political Economy Vol. Vol. 91.
*OR, Ch. 4.
Obstfeld, M. (1983) "Intertemporal Price Speculation and the Optimal Current Account Deficit"
Journal of International Money and Finance, Vol. 2.
Edwards, S. (1991) Real Exchange Rates, Devaluation and Adjustment The MIT Press, Chs. 1-3.
IV. Exchange Rate Determination and Macroeconomic Balance under Flexible Prices
1. The Monetary and Asset Market Approaches
*Obstfeld, M. (1981) "Imperfect Asset Substitutability and Monetary Policy under Fixed Exchange
Rates" Journal of International Economics.
__________ (1982) "The Capitalization of Income Streams and the Effects of Open Market
Operations under Fixed Exchange Rates" Journal of Monetary Economics, Vol. 9.
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OR, Ch. 8.
Calvo, G. and C. Rodriguez (1977) "A Model of Exchange Determination under Currency
Substitution and Rational Expectations" Journal of Political Economy, Vol. 85, pp. 617-625.
Kouri, P. (1976) "The Exchange Rate and the Balance of Payments in the Long Run and the Short
Run: A Monetary Approach" Scandinavian Journal of Economics, Vol. 78, pp. 280-304.
Frenkel. J. and C. Rodriguez (1975) "Portfolio Equilibrium and the Balance of Payments: A
Monetary Approach" American Economic Review, Vol. 65, 674-688.
Dornbusch, R. (1975) "A Portfolio Balance Model of the Open Economy" Journal of Monetary
Economics, Vol. 1, pp. 3-20.
Mussa, M. (1974) "A Monetary Approach to Balance of Payments Analysis" Journal of Money,
Credit and Banking, Vol. 6, pp. 333-351.
2. Optimizing Models with Money
*Calvo, G. (1981) "Devaluation: Levels versus Rates" Journal of International Economics, Vol. 11,
pp. 165-172.
*Obstfeld, M. (1981) "Macroeconomic Policy, Exchange Rate Dynamics and Optimal Asset
Accumulation" Journal of Political Economy, Vol. 89, pp. 1142-1161.
OR, Ch. 8.
____________ and A. Stockman "Exchange Rate Dynamics" in Handbook of International
Economics, Vol. 2, Section 5.
Second problem set
V. Exchange Rate Determination and Macroeconomic Balance under Sticky Prices
1. The Classics
Mundell. R. (1963) "Capital Mobility and Stabilization Policy under Fixed and Flexible Exchange
Rates" Quarterly Journal of Economics, Vol. 74, pp. 227-257.
Fleming, M. (1969) "Domestic Financial Policies under Fixed and under Floating Exchange Rates"
IMF Staff Papers, Vol. 9, pp. 379-390.
Frenkel, J. and A. Razin (1987) "The Mundell-Fleming Model a Quarter Century Later: A Unified
Exposition" IMF Staff Papers, Vol. 27.
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*Dornbusch, R. (1976) "Expectations and Exchange Rate Dynamics" Journal of Political Economy,
Vol. 24, pp.1161-1176.
2. More Modern Classics
*Calvo, G. (1983) "Staggered Prices in a Utility-Maximizing Framework" Journal of Monetary
Economics, Vol. 12, No. 3.
*Calvo, G.A., and C.A. Végh, "Credibility and the Dynamics of Stabilization Policy: A Basic
Framework," in C. Sims, ed., Advances in Econometrics: Sixth World Congress, Vol. II (Cambridge:
Cambridge University Press, 1994), pp. 377-420..
Obstfeld, M. and K. Rogoff "Exchange Rate Dynamics with Sluggish Prices under Alternative Price
Adjustment Rules" International Economic Review, Vol. 25, No.1, February 1984.
3. The “New” Open-Economy Macroeconomics
OR, Chs. 9 and 10.
*Obstfeld, M. and K. Rogoff "Exchange Rate Dynamics Redux" Journal of Political Economy, Vol.
102, June 1995.
Corsetti, G. and P. Pesenti, “Welfare and Interdependence,” Quarterly Journal of Economics, 2001.
Lane, P. “The New Open-Economy Macroeconomics: A Survey,” Journal of International
Economics, 2002.
Chari, V.V., Patrick K. Kehoe, and Ellen R. McGratten, "Monetary Shocks and Real Exchange
Rates in Sticky Price Models of International Real Business Cycles," mimeo, Federal Reserve Bank
of Minneapolis, 1996.
VI. Stabilization Policies
1. Background
*Vegh, C. "Stopping High Inflation: An Analytical Overview" IMF Staff Papers, 1992.
*AM, Ch. 10, 12.
Rebelo, S., and C.A. Végh, "Real Effects of Exchange Rate-Based Stabilization: An Analysis of
Competing Theories," NBER Macroeconomics Annual 1995, pp. 125-174.
Sargent, T. "The Ends of Four Big Inflations" in Rational Expectations and Inflation, 1986.
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___________ "Stopping Moderate Inflations: The Methods of Poincare and Thatcher" in R.
Dornbusch and M.H. Simonsen (eds.) Inflation, Debt and Indexation, Cambridge: The MIT Press,
1986.
Dornbusch, R. (1988) "Inflation Stabilization and Capital Mobility" in Exchange Rates and
Inflation. The MIT Press.
2. Credibility
*Calvo, Guillermo A. and Carlos A. Végh, "Exchange Rate-Based Stabilisation under Imperfect
Credibility" in Open-Economy Macroeconomics, by Helmut Frisch and Andreas Worgotter
(London:MacMillan Press, 1993), pp. 3-28. Reprinted as Chapter 18- in Calvo’s colleteted essays
volume.
*Dornbusch, R. “Credibility and Stabilization,” Quarterly Journal of Economics Vol. 106, 1991.
Calvo, G. "Temporary Stabilization: The Case of Predetermined Exchange Rates" Journal of
Political Economy, 1986b.
3. Sticky Inflation and Real Exchange Rate Overshooting
*OR, Ch. 9.
*Calvo, G.A., y C.A. Végh, "Stabilization Dynamics and Backward-Looking Contracts," Journal of
Development Economics, Vol. 43 (February 1994), pp. 59-84.
*Ghezzi, P. “Bacward-looking Indexation, Credibility and Inflation Persistence,” Journal of
International Economics, Vol. 53, No. 1, 2001.
Celasun, O. “Sticky Inflation and the Real Effects of Exchange-Rate Based Stabilization,” IMF
Working Paper 03/151, 2003.
Galí, J. and M. Gertler, “Inflation Dynamics: A Structural Econometric Analysis,” Journal of
Monetary Economics, No. 44, 1999.
Buiter, W. and M. Miller (1981) "Real Exchange Rate Overshooting and the Output Costs of
Bringing Down Inflation" in International Macroeconomics J. Frenkel (ed.).
VII. Exchange Rate Regimes
1. Regime Characteristics
*Rogoff, Ken, Aasim M. Husain, Ashoka Mody, Robin J. Brooks, and Nienke Oomes, “Evolution
and Performance of Exchange Rates Regimes,” forthcoming as an International Monetary Fund
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Occasional Paper, 2004. Earlier version IMF Working Paper WP03/243, December 2003. Paper is
posted in course website.
*Obstfeld, M. and K. Rogoff, “The Mirage of Fixed Exchange Rates,” Journal of Economic
Perspectives, 1995.
*Reinhart, C. “The Mirage of Flexible Exchange Rates,” American Economic Review, May 2000.
Velasco, A. and F. Larraín, “Exchange Rate Policy in Emerging-Market Economies: The Case for
Floating,” Princeton Essays in International Finance, No. 224, December 2001.
Obstfeld, M, “International Currency Experience: New Lessons and Lessons Re-Learned,”
Brookings Papers in Economic Activity, 1: 1995.
Friedman, M. "The Case for Flexible Exchange Rates" in Essays in Positive Economics. University
of Chicago Press, 1953.
Johnson, H. "The Case for Flexible Exchange Rates, 1969" Federal Reserve Bank of St. Louis
Review, Vol. 51, June 1969.
Obstfeld, M. "Floating Exchange Rates: Experience and Prospects" Brookings Papers on Economic
Activity, 1985.
Aschauer, D. and J. Greenwood "A Further Exploration in the Theory of Exchange Rate Regimes"
Journal of Political Economy, Vol. 91, No. 5, 1983.
Helpman, E. and A. Razin "Toward a Consistent Comparison of Alternative Exchange Rate
Regimes" Canadian Journal of Economics, 1979.
Svensson, L. E. O. "Fixed Exchange Rates as a Means to Price Stability: What Have We
Learned?" NBER Working Paper No. 4504, October 1993.
2. Shocks and the Insulating Properties of Alternative Regimes
*Calvo, G. “Fixed vs. Flexible Exchange Rates: Preliminaries of a Turn-of-Millennium
Rematch,” May 1999. In http://www.bsos.umd.edu/econ/.
*HIE, Chapter 17, especially sections 5 and 6.
Flood, Robert, “Capital Mobility and the Choice of Exchange Rate System,” International
Economic Review, Vol. 2, June 1979.
Fischer, Stanley, “Stability and Exchange Rate Systems in a Monetarist Model of the
Balance of Payments,” in The Political Economy of Monetary Reform, Robert Aliber (ed.),
1977.
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Flood, Robert P., and Nancy P. Marion, “The Transmission of Disturbances under
Alternative Exchange-Rate Regimes with Optimal Indexing,” Quarterly Journal of
Economics 97, 1, February 1982: 43-66.
Aizenman, Joshua, and Jacob A. Frenkel, “Optimal Wage Indexation, Foreign Exchange
Intervention, and Monetary Policy,” American Economic Review, 73, 3, June 1985: 402-423.
3. Credibility, Flexibility and Discipline
*Velasco, A. “Fixed Exchange Rates: Credibility, Flexibility and Multiplicity,” European Economic
Review, May 1996.
*Rogoff, K. “The Optimal Degree of Commitment to an Intermediate Monetary Target'' Quarterly
Journal of Economics Vol. 100, pp. 1169-90, 1985.
OR, Ch. 9, sections 9.4 and 9.5.
Drazen, A. and P. Masson “Credibility of Policies versus Credibility of Policymakers'' NBER
Working Paper No. 4488, September 1993.
Cukierman, A., M. Kiguel and N. Liviatan "How Much to Commit to and Exchange Rate Rule?
Balancing Credibility and Flexibility" World Bank Working Paper WPS 931, July 1992.
Tornell, A. and A. Velasco “Fixed versus Flexible Exchange Rates: Which Provides More Fiscal
Discipline?” Journal of Monetary Economics, 2000.
De Kock, G. and V. Grilli "Fiscal Policies and the Choice of Exchange Rate Regime" The Economic
Journal, Vol 103, March 1993.
4. Imperfect Financial Markets and Monetary Policy
*Krugman, P. Analytical Afterthoughts on the Asian Crisis.'' in
http://www.wws.princeton.edu/~pkrugman/.
*Céspedes, L. F., R. Chang and A. Velasco, “IS-LM-BP in the Pampas.” IMF Staff Papers, Vol. 50,
2003, pp. 143-156.
Céspedes, L. F., R. Chang and A. Velasco, “Balance Sheets and Exchange Rate Policy,”
Forthcoming, American Economic Review, 2004.
Aghion, P., P. Bachetta and A. Banerjee, “Currency Crises and Monetary Policy in an Economy
with Credit Constraints,” European Economic Review, 2001.
Midterm
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VIII. Monetary and Fiscal Policy in the Open Economy
1. Basic Relations
*Obstfeld, M. “Notes on Seigniorage and Budget Constraints” at
http://emlab.Berkeley.EDU/users/obstfeld/e202b/e202b.html
*AM, Ch. 5
2. Fiscal Policy in the Open Economy Ramsey Model
*Blanchard, O. and Fischer, S. (1989) Lectures in Macroeconomics, Chapter 2.3.
3. Fiscal Policy and Monetarist Arithmetic
*Drazen, A. "Tight Money and Inflation: Further Results" Journal of Monetary Economics, Vol. 15,
1984.
* AM, Ch. 5.3.2
OR, Ch. 8, section 2.
Drazen, A. and E. Helpman, “Inflationary Consequences of Anticipated Macroeconomic Policies,”
Review of Economic Studies, Vol. 57, 1990.
Drazen, A. and E. Helpman, "Stabilization with Exchange Rate Management" Quarterly Journal of
Economics, 1987, pp. 835-855.
Velasco, A. “Real Interest Rates and Government Debt During Stabilization,” Journal of Money,
Credit and Banking, April 1993.
IX. Speculative Attacks and Currency Crises
1. Speculative Attacks: Background
*AM, Ch. 16.4
2. Speculative Attacks: First Generation
*OR, Ch. 8
* AM, Ch. 16.1
*Flood, R. and P. Garber (1984) "Collapsing Exchange Rates: Some Linear Examples" Journal of
International Economics.
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Garber, P. and L. Svensson, "The Operation and Collapse of Fixed Exchange Rates" in GR.
Krugman, P. (1979) "A Theory of Balance of Payments Crises" Journal of Money, Credit and
Banking, Vol. 11, pp. 311-325.
Third problem set
3. Speculative Attacks: Second Generation
*Obstfeld, M. “The Logic of Currency Crises'' Cahiers Economiques et Monetaires, No. 43, 1994.
*AM, Ch. 16.2
*Krugman, Paul, “Are Currency Crises Self-Fulfilling?,'' in Ben Bernanke and J. Rotembers, eds.,
NBER Macroeconomics Annual, 1996. Cambridge, Mass: MIT Press, 1996, pp. 345-407. (Includes
comments by Tim Kehoe, Maurice Obstfeld and Peter Garber).
Sachs, J., A. Tornell and A. Velasco, “The Mexican Peso Crisis: Sudden Death or Death Foretold?"
(with J. Sachs and A. Tornell). Journal of International Economics, 1996.
Obstfeld, M. "Rational and Self-Fulfilling Balance of Payments Crises" American Economic
Review, Vol. 76, pp. 72-81, 1986.
_________________ “A Model of Currency Depreciation and the Debt-Inflation Spiral,” Journal of
Economic Dynamics and Control, April 1991.
Ozkan, F. G.. and A. Sutherland, “Policy Measures to Avoid a Currency Crisis'' The Economic
Journal, Vol. 105, March 1995.
Jeanne, O. “Models of Currency Crises: A Tentative Synthesis with Special Reference to the
1992-93 EMS Crisis'' mimeo, ENPC-CERAS, December 1994.
4. Speculative Attacks: Third Generation
*Velasco, A. “The Impossible Duo? Globalization and Monetary Independence in Emerging
Markets” Brookings Trade Forum 2001. Washington: Brookings Institution Press. Pages 69-80
*Krugman, P., “Balance Sheets, the Transfer Problem and Financial Crises,” in International
Finance and Financial Crises: Essays in Honor of Robert Flood, P. Isard, A. Razin and A. Rose
(eds.), Kluwer Academic Publishers, 1999.
Fourth problem set
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X. Capital Flows, Debt Maturity and Banks
1. The Problem
*Calvo, G. “Capital Flows and Capital-Market Crises: The Simple Economics of Sudden Stops, “
July 20, 1998, at http://www.bsos.umd.edu/econ/ciecrp.htm.
*AM, Ch. 15
Chang, R. and A. Velasco, “The Asian Financial Crisis in Perspective” (with R. Chang), in Private
Capital Flows in the Age of Globalisation : The Aftermath of the Asian Crisis, Uri Dadush , Dipak
Dasgupta and Marc Uzan (eds). New York: Edgar Elgar Publishers, 2000.
Sachs, J., “Alternative Approaches to Financial Crises in Emerging Markets,” Development
Discussion Paper No. 568, Harvard Institute for International Development, January 1997.
2. Debt Maturity
*Rodrik, D. and A. Velasco “Short-Term Capital Flows,” Annual World Bank Conference on
Development Economics, 2000.
*Calvo, G. “Servicing the Public Debt: The Role of Expectations,” American Economic Review,
Vol. 78, September 1988.
Calvo, G. “Varieties of Capital Market Crises” in Calvo and King, (eds.), The Debt Burden and its
Consequences for Monetary Policy, MacMillan, 1998.
Cole, H. and T. Kehoe, “A Self-Fulfilling Model of Mexico’s Debt Crisis,” Journal of Interntional
Economics, Vol. 41, 1996.
Detragiache, E. “Rational Liquidity Crises in the Sovereign Debt Market: In Search of a Theory,''
IMF Staff Papers, Vol 43, No. 3, 1996.
3. The Role of Banks
*Chang, R. and A. Velasco, “Illiquidity and Crises in Emerging Markets: Theory and Policy,”
NBER Macroeconomics Annual, 1999.
_____________________, “Financial Fragility and the Exchange Rate Regime” Journal of
Economic Theory, 2000.
____________________, “A Model of Financial Crisis in Emerging Markets,” Quarterly Journal of
Economics, 2001.
Goldfajn, I. and R. Valdes, “Capital Flows and the Twin Crises: The Role of Liquidity,'' Working
Paper 97-87, International Monetary Fund, July 1997.
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