Download ECON 8423-001 International Finance

International Finance
Economics 8423
University of Colorado at Boulder
Spring 1996
JoAnne Feeney
Course Description
Some empirical puzzles:
(1)
(2)
(3)
(4)
(5)
(6)
(7)
There is very little international diversification of portfolios.
Consumption is less well correlated across countries than one might expect.
Exchange-rate systems seem to affect the behavior of real exchange rates.
Real and nominal exchange rates move together very closely.
Exchange rate movements are very persistent with little short-run dynamics (no mean reversion).
Forward exchange rates are poor and biased predictors of the future spot rate.
- on average the forward premium predicts the wrong direction for the change in the spot rate
Why are international differences in interest rates so large and persistent?
Some other questions:
(8)
(9)
(10)
(11)
(12)
(13)
What are the causes of changes in exchange rates?
What are the effects of changes in exchange rates (or the shocks that caused them)?
What causes changes in the balance of trade (and current account)?
What are the allocative or distributional effects of alternative exchange-rate systems?
Under what conditions can we rank (or even compare) exchange-rate systems in terms of welfare?
Are business cycles transmitted from one country to another? Or are there common shocks across
countries?
This course is divided into three sections. In Section I we will focus on the two roles that international financial
markets (IFM) play for nations:
(i)
Intertemporal trade: IFM allow a country to consume more in aggregate than it produces in any
given time period. In other words, IFM permit borrowing and lending at the national level.
(Trade across time)
(ii)
International risk sharing: IFM permit countries to pool risk. (Trade across states)
In each of these contexts we want to understand the gains from trade on international financial markets. We want
to know how a country's access to IFM is likely to affect welfare of its citizens and how it may influence production
decisions of its firms. We will find that IFM will, in general, affect the pattern over time of aggregate consumption
in a country, as well as investment, capital accumulation, and output.
In addition, we will examine current account dynamics to try to understand how different types of shocks productivity, preferences, or terms of trade shocks (for a small country) - often create different behavior of the
current account. We also want to understand the correlations among the current account and (real and nominal)
exchange rates, consumption across countries, output across countries, etc.
In Section II we study the determination of exchange rates. We examine the empirical observations of the behavior
of exchange rates in the modem floating rate period and we consider numerous models that attempt to explain this
behavior. We also analyze the relative merits of fixed versus flexible exchange rates in theory and in practice.
In Section m we consider some topics which may include international business cycles, the so-called "international
debt crisis,• policy coordination, and capital controls.
Course Readings and Requirements
The most important readings on the list that follows are marked with an asterisk. Some of these will be discussed
in class, although you are responsible for all of them unless otherwise noted. The remaining papers are provided
as a reference for future research or_for additional insight. In addition to these readings, I have prepared some
supplementary notes which offer further explanation of some sections of the material. These will be made available.
Papers marked with an asterisk and the supplemental notes will be placed in the filing cabinet in the third floor
student lounge.
There will be two examinations in this course - a midterm exam and a final exam. In addition, you will be
required to write a paper: this may either focus on an original research idea or may be a comprehensive
survey/critique of one area of the international finance literature of your choosing. A two-page topic description
is due Monday, February S. The topic is subject to approval. The final draft of the paper is due Monday, April
22. Paper presentations will take place during class the weeks of April 22 and April 29. Further details will be
provided.
The Final Exam is scheduled for Friday, May 10, 11:30am - 2:30pm.
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Readig List
I. INTERNATIONAL FINANCIAL MARKETS AND INTERTEMPORAL TRADE
1.0. General
*
Alan C. Stockman, "Some Interactions between Goods Markets and Asset Markets in Open Economies,•
in S. Arndt and D. Richardson (eds.) Real-Financial Linkages among Open Economies, Cambridge, MA: MIT
Press, (1987).
1.1. Trade over Time {under Certainty)
*
Torsten Persson and Alan C. Stockman, The Theory of International Financial Markets, "Two By Two
Trade Across Time,• Chapter 1 of incomplete manuscript, (1987).
*
Maurice Obstfeld and Kenneth Rogoff, . "The Intertemporal Approach to the Current Account,• NBER
Working Paper No. 4893 (October 1994).
*
Torsten Persson and Lars Svensson, "Current Account Dynamics and the Terms of Trade: HarbergerLaursen-Metzler Two Generations Later,• Journal of Political Economy 93 (1985), 43-65.
Mary Finn, "On Savings and Investment Dynamics in a Small Open Economy, • (1989).
David Backus, Patrick Kehoe, and Finn Kydland, "Dynamics of the Trade Balance and the Terms of Trade:
The J-Curve Revisited,• lnstitue for Empirical Macroeconomics Discussion Paper 65, Federal Reserve Bank of
Minneapolis (1992).
Martin Feldstein and C. Horioka, "Domestic Saving and International Capital Flows,• Economic Journal
90 (1980), 314-329.
Martin Feldstein, "Domestic Saving and International Capital Movements in the Long Run and the Short
Run," European Economic Review 21 (March/April 1983), 129-51.
*
Linda Tesar, "Savings, Investment, and International Capital Flows,• Journal of International Economics
31 (1991) 55-78.
1.2 Trade across States of Nature Ontemational Financial Markets in the Presence of Uncertainty)
Lars E. 0. Svensson, "Trade in Risky Assets," American Economic Review 78, No. 3 (June 1988), 375-94.
*
Torsten Persson and Alan C. Stockman, The Theory of International Financial Markets, chapter 5, "TwoBy-Two Trade Across States of Nature,• (1987).
John Pomery, "Uncertainty in Trade Models, " Chapter 9 in Ronald Jones and Peter Kenen, eds. , Handbook
of International Economics l, Amsterdam: North-Holland, (1984).
Elhanan Helpman and Assaf Razin, A Theory of Inlernational Trade under Uncertainty, New York:
Academic Press, (1978).
Gene M. Grossman and Assaf Razin, "The Pattern of Trade in a Ricardian Model with Country-Specific
Uncertainty,• lnlernational Economic Review 26, No. 1 (February 1985).
*
Alan C. Stockman and Harris Dellas, "Tariffs, Asset Markets, and Political Risk,• Journal ofInternational
Economics 21 (November 1986), 199-214.
INCOMPLETE MARKETS
Gene Grossman and AssafRazin, "International Capital Movements under Uncertainty,• Journal ofPolitical
Economy (April 1984), 286-306.
*
Jonathan Eaton and Gene Grossman, "Tariffs as Insurance: Optimal Commercial Policy when Domestic
Markets are Incomplete,• Canadian Journal of Economics 18, No. 2 (May 1985), 258-272.
*
Avinash Dixit, "Trade and Insurance with Moral Haz.ard, • JIE 23, No. 3/4 (November 1987), 201-20.
*
JoAnne Feeney, "Goods and Asset Market Interdependence in a Risky World," International Economic
Review 35(3) (August 1994), 551-563.
*
Harold L. Cole and Maurice Obstfeld, "Commodity Trade and International Risk Sharing: How Much do
Financial Markets Matter?" Journal of Monetary Economics 28, 3-24 (1991).
*
Maurice Obstfeld, "Risk-taking, Global Diversification, and Growth,• American Economic Review 84(5)
(December 1994), 1310-1329.
*
Michael Devereux and Gregor Smith, "International Risk Sharing and Economic Growth,• International
Economic Review 35(3) (August 1994), 535-550.
*
Alan C. Stockman, "On the Roles of International Financial Markets and Their Relevance for Economic
Policy," Journal of Money, Credit, and Banking 20, Vol. 3 (August 1988), 531-49.
*
Marianne Baxter, Urban Jermann, and Robert King, "Nontraded Goods, Nontraded Factors, and
International Nondiversification, • NBER WP #5175, July 1995.
EVIDENCE
*
Linda Tesar and Ingrid Werner, "Home Bias and the Globalization of Securities Markets,• NBER working
paper, 1993.
*
Maurice Obstfeld, "International Capital Mobility in the 1990's, • in Peter Kenen (ed) Understanding
Interdependence, Princeton University Press, 1995, pp. 201-261.
Robert Cumby and Maurice Obstfeld, "International Interest Rate and Price-Level Linkages under Flexible
Exchange Rates: A review of Recent Evidence, • in J. Bilson and R. Marston (ed.), Exchange Rates: Theory and
Practice, Univ. Chicago Press, (1982).
Maurice Obstfeld, "How Integrated are World Capital Markets? Some New Tests," NBER WP 2075,
(November 1986).
Nelson Mark, "Some Evidence on the International Inequality of Real Interest Rates," Journal of
International Money and Finance 4, No. 3 (June 1985), 189-208.
II. EXCHANGE RATES
11.1 Models of Flexible Exchange Rates
GENERAL
Anne Krueger, Exchange Rate Detennination, Cambridge Swveys of Economic Literature, Cambridge:
Cambridge University Press.
Maurice Obstfeld and Alan Stockman, •Exchange Rate Dynamics: R. Jones and P. Kenen (eds.),
Handbook of International Economics, Vol. II, Amsterdam: North-Holland, (1985).
Maurice Obstfeld, •International Finance,• The New Palgrave, (1987), 898-906.
EQUILIBRIUM MODELS
Alan C. Stockman, •A Theory of Exchange Rate Determination," Journal ofPolitical Economy 88 (1980),
673-98.
Milton Friedman, •1ne Case for Flexible Exchange Rates,• in Essays in Positive Economics, University
of Chicago Press, (1951).
*
Robert Lucas, •Interest Rates and Currency Prices in a Two-Country world,• Journal of Monetary
Economics 10 (1982), 728-54.
*
Alan C. Stockman, •Tue Equilibrium Approach to Exchange Rates," Economic Review, Federal Reserve
Bank of Richmond, (March-April 1987), 12-31.
Alan C. Stockman, "The Cash-in-Advance Constraint in International Economics,• M. Kohn (ed.), Finance
Constraints and the Theory of Money: Collected Papers of S.C. Tsiang, Academic Press, (1988).
*
Alan Stockman and Harris Dellas, "International Portfolio Nondiversification and Exchange Rate
Variability," Journal of International Economics 26, no. 3/4 (May 1989), 271-290.
DISEOUILIBRIDM MODELS
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Rudiger Dornbusch, "Expectations and Exchange Rate Dynamics,• Journal ofPolitical Economy 84 (1976),
1161-76.
*
Alan Stockman and Lee Ohanian, "Short-run Independence of Monetary Policy under Pegged Exchange
Rates and Effects of Money on Exchange Rates and Prices,• manuscript, 1993.
Maurice Obstfeld and Kenneth Rogoff, •Exchange Rate Dynamics with Sluggish Prices Under Alternative
Price-Adjustment Rules," International Economic Review 25, No. 1 (February 1984), 159-74.
Lars Svensson and Sweder van Wijnbergen, "Excess Capacity, Monopolistic Competition, and the
International Transmission of Monetary Policy," Economic Journal 99(397), September 1989, 785-805.
*
Obstfeld and Rogoff, •Exchange Rates Dynamics Redux," American Economic Review 1995
BEHAVIOR OF EXCHANGE RATES
*
Richard Meese and Kenneth Rogoff, "Empirical Exchange Rate Models of the Seventies: Do They Fit Out
of Sample?" Journal of lnterna1ional Economics 14 (1983), 3-24.
Richard Meese and Kenneth Rogoff, The Out-of-Sample Failure of Empirical Exchange Rate Models:
Sampling Error or Misspecification?" in J. Frenkel (ed.), Exchange Rqtes and International Macroeconomics,
University of Chicago Press, (1983).
*
Richard Meese and Kenneth Rogoff, "Was It Real? The Exchange Rate-Interest Differential Relation over
the Modem Floating-Rate Period," Journal of Finance 43 No. 4 (September 1988), 933-48.
*
John Campbell and Richard Clarida, 1986, "The Dollar and Real Interest Rates," Carnegie-Rochester
Conference Series on Public Policy 21 (1987),103-40.
*
John Huizinga, "An Empirical Investigation of the Long-Run Behavior of Real Exchange Rates,"
forthcoming, Carnegie-Rochester Conference Series, (1987).
*
Charles Engle, "Real Exchange Rates and Relative Prices: An Empirical Investigation," NBER WP #4231,
December 1992.
*
Martin Eichenbaum and Charles Evans, "Some Empirical Evidence on the Effects of Monetary Policy
Shocks on Exchange Rates," NBER WP #4271, Feb. 1993.
*
Robert Cumby and John Huizinga, "The Predictability of Real Exchange Rate Changes in the Short Run
and Long Run," NBER WP #3468, 1990.
Charles Engel and James D. Hamilton, "Long Swings in the Exchange Rate: Are They in the Data and
Do Markets Know It?" NBER WP 3165, (November 1989).
*
Charles Engel and John Rogers, "Regional Patterns in the Law of One Price: The Roles of Geography
versus Currencies," NBER WP #5395, December 1995.
*
Charles Engel, "Accounting for US Real Exchange Rate Changes," NBER WP #5394, December 1995.
Richard T. Baillie and Tim Bolerslev, "Common Stochastic Trends in a System of Exchange Rates,"
Journal of Finance 44, No. 1 (March 1989), 167-82.
THE BUDGET DEF1CIT. THE CURRENT ACCOUNT. AND THE DOLLAR
*
Martin Feldstein, "The Budget Deficit and the Dollar," NBER Macroeconomics Annual, 1986, 355-392,
and comments by Rudiger Dornbusch and Alan C. Stockman, pp. 393-407.
*
Paul Evans, "Is the Dollar High Because of Large Budget Deficits?" Journal of Monetary Economics 18,
No. 3 (November 1986), 227-50.
FORWARD EXCHANGE RATES
Lars Hansen and Robert Hodrick, "Risk Averse Speculation in the Foreign Exchange Market," in E.
Claassen and P. Salin (eds.), Recent Issues in the Theory of Flexible Exchange Rates, North-Holland, 1981.
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*
Alan C. Stockman, "Risk, Information, and Forward Exchange Rates," in J. Frenkel and H. Johnson (ed.)
The Economics of Exchange Rates, 1978.
Eugene Fama, "Forward and Spot Exchange Rates," Journal ofMonetary Economics 14, No. 3, November
1984, 319-338.
Robert Hodrick, "Risk, Uncertainty, and Exchange Rates," Journal ofMonetary Economics 23, May 1989,
433-59.
*
Jeffrey A. Frankel and Kenneth Froot, "Using Survey Data to Test Standard Propositions Regarding
Exchange Rate Expectations," American Economic Review 77, No. 1 (March 1987), 133-153.
EXCHANGE RATE REGIMES AND ALTERNATIVE MONETARY SYSTEMS
*
Elhaoan Helpman, "An Exploration in the Theory of Exchange Rate Regimes," Journal of Political
Economy 89 (October 1981), 865-890.
*
D. Kimbrough, "International Linkages, Exchange Rate Regimes and the International Transmission
Process: Perspectives from Optimizing Models," in L. Officer (ed.) International Economics (Kluner-Nijhold:
Boston), (1986).
*
Alan Stockman, "Real Exchange Rates Under Alternative Nominal Exchange Rate Systems," Journal of
International Money and Finance 2 (August 1983), 147-66.
*
Barry Eichengreen, "The Endogeneity of Exchange-Rate Regimes," Ch. 1 in Peter Kenen (ed.)
Understanding Interdependence, Princeton University Press, 1995, pp. 3-33.
*
Alan C. Stockman, "Real Exchange Rate Variability under Pegged and Floating Nominal Exchange Rate
Systems: An Equilibrium Theory," in K. Brunner and A.H. Meltzer (eds.), Carnegie-Rochester Conference Series
on Public Policy 29 (Autumn 1988), 259-94.
*
Marianne Baxter and Alan C. Stockman, "Business Cycles and the Exchange Rate Regime:
International Evidence," Journal of Monetary Economics 23, No. 3 (May 1989), 377-400.
Some
*
Alan Stockman and Lee Ohanian, "Short-run Independence of Monetary Policy under Pegged Exchange
Rates and Effects of Money on Exchange Rates and Prices," manuscript, 1993.
*
Jeffrey A. Frankel and Richard Meese, "Are Exchange Rates Excessively Variable?," NBER WP No. 2249
(May 1987).
Harris Dellas, "Time Consistency and the Feasibility of Alternative Exchange Rate Regimes, Journal of
Monetary Economics 22, No. 3 (November 1988), 461-72.
ill. SELECTED TOPICS
ill.1 Devaluation and Related Issues
Paul Krugman, "A Model of Balance of Payments Crises," Journal of Money, Credit and Banking, 1979.
Robert Flood and Peter Garber, "A Model of Stochastic Process Switching," Econometrica 51 (May 1983),
537-51.
Robert Flood and Peter Garber, "Collapsing Exchange Rate Regimes: Some Linear Examples,• Journal
of /nternaJional Economics 11 (August 1984), 1-14.
Robert Flood and Peter Garber, "The Linkage between Speculative Attack and Target Zone Models of
Exchange Rates, • Quarterly Journal of Economics 106(4), November 1991, 1367-72.
Vittorio Grilli, "Buying and Selling Attacks on Fixed Exchange Rate Systems,• JIE 20, No. 1/2 (February
1986), 143-56.
Maurice Obstfeld, "Balance-of-Payments Crises and Devaluation,• Journal of Money, Credit and Banking
16 (May 1984), 208-17.
Guillermo Calvo, "Balance of Payments Crises in a Cash-in-Advance Economy,• Journal of Money, Credit
and Banking (1986).
Maurice Obstfeld, "Capital Mobility and Devaluation in an Optimizing Model with Rational Expectations, •
American Economic Review 11, No. 2 (May 1981), 217-221.
Gregor W. Smith, "Stochastic Process Switching,• Queens University.
Alessandro Penati and George Pennacchi, "Optimal Portfolio Choice and the Collapse of a Fixed-Exchange
Rate Regime,• (August 1986).
Maurice Obstfeld, "Rational and Self-Fulfilling Balance-of-Payments Crises,• American Economic Review
76, No 1 (March 1986), 72-81.
Kenneth A. Froot and Maurice Obstfeld, "Exchange Rate Dynamics under Stochastic Regime Shifts: A
Unified Approach,• Journal of /nternaJional Economics 31(3/4), November 1991, 203-30.
Lars E.O. Svensson, "Why Exchange-Rate Bands? Monetary Independence in Spite of Fixed Rates,• NBER
WP #4207, November 1992.
Peter M. Garber and Vittorio Grilli, "Banlc Runs in Open Economies and the International Transmission
of Panics,• NBER WP 2764 (November 1988).
m.2
Sterilimtion, Official Intervention, and Monetary Policies
Kenneth Rogoff, "On the Effects of Sterilized Intervention: An Analysis of Weekly Data,• Journal of
Monetary Economics 14 (1984), 133-50.
Warren Weber, "Do Sterilized Interventions Affect Exchange Rates?" Quarterly Review, Federal Reserve
Banlc of Minneapolis, (Summer 1986).
Maurice Obstfeld, "The Effectiveness of Foreign-Exchange Intervention: Recent Experience,• NBER WP
2796 (December 1988).
m.3 Exchruy:e Controls, Capital Controls, and Commercial Policies
Charles Adams and Jeremy Greenwood, "Dual Exchange Rate Systems and Capital Controls:
Investigation,• Journal of /nternaJional Economics 18 (1985), 43-63.
An
Alan Stockman and Alejandro Hernandez, "Exchange Controls, Capital Controls, and International
Financial Markets, • American Economic Review (June 1989), 362-74.
Enrique Mendoza, "Capital Controls and the Gains from Trade in a Business Cycle Model of a Small Open
Economy," IMF Staff Papers 38(3), 480-505 (September 1991).
m.4.
Fiscal Policies
Assaf Razin and Lars Svensson, "The Current Account and Optimal Government Debt," Journal of
International Money and Finance 2 (1983), 215-24.
Shagil Ahmed, "Temporary and Permanent Government Spending in an Open Economy: Some Evidence
for the UK, " Journal of Monetary Economics 17, No. 2 (March 1986), 197-224.
*
Alan C. Stockman, "Fiscal Policies and International Financial Markets," in J. Frenkel (ed.), Open
Economy Aspects of Fiscal Policy, Chicago, University of Chicago Press, 1988.
Jeremy Greenwood and Kent P. Kimbrough, "Capital Controls and Fiscal Policy in the World Economy,•
Canadian Journal of Economics 18 (November 1985), 743-65.
*
Michael Devereux, "Fiscal Spending, the Terms of Trade, and Real Interest Rates, " Journal of
International Economics 22 (1987), 219-235.
ill.S. International Transmmion
*
David Backus, Patrick Kehoe, and Finn Kydland, "International Business Cycles: Theory and Evidence, "
Ch. 11 in Thomas Cooley (ed.) Frontiers of Business Cycle Research, Princeton University Press, 1995.
*
Alan C. Stockman, "Sectoral and National Aggregate Disturbances to Industrial Output in Seven European
Countries," Journal of Monetary Economics (March/May 1988), 387-410.
*
Donna Costello, "A Cross-Country, Cross-Industry Comparison of Productivity Growth," Journal of
Political Economy, (1993).
*
Marianne Baxter and Mario Crucini, "Business Cycles and the Asset Structure of Foreign Trade,"
International Economic Review 36(4), November 1995, pp.821-854.
*
David Backus and Gregor Smith, "Consumption and Real Exchange Rates in Dynamic Economies with
Nontraded Goods," Journal of Internarional Economics 35(3/4), November 1993, pp. 297-316.
Richard Marston, "Stabilization Policy in Open Economies," R. Jones and P. Kenen (eds.), Handbook of
International Economics, Vol. II, Amsterdam: North-Holland, (1984).
Jeremy Greenwood and Stephen Williamson, "International Financial Intermediation and Aggregate
Fluctuations under Alternative Exchange Rate Regimes, • Journal of Monetary Economics 23, No. 3 (May 1989),
401-32.
Alan C. Stockman, "Exchange Rates, the Current Account, and Monetary Policy, " forthcoming, in W.S.
Haraf (ed.) Monetary Policy in a World of Change, Washington, D.C. : American Enterprise Institute, forthcoming
(1990) and comments by J. Frankel.
*
Alan Stockman and Linda Tesar, "Tastes and Technology in a Two-Country Model of the Business Cycle:
Explaining International Comovements," manuscript (1992).
Harris Dellas, "A Real Model of the World Business Cycle," Journal of International Money and Finance
5, September 1986, 381-94.
m.6.
Policy Coordination
*
Patrick]. Kehoe, "Coordination of Fiscal Policies in a World Economy," Journal of Monetary Economics
19, No. 3 (May 1987), 349-76.
*
Alberto Alesina and Allan Draren, "Why are Stabilizations Delayed?" American Economic Review, 81, pp.
1170-88.
Kenneth Rogoff, "Can International Monetary Policy Cooperation be Counterproductive?" Journal of
International Economics 18 (May 1985), 199-218.
Barry Eichengreen, "International Policy Coordination in Historical Perspective: A View From the
Interwar Years," International Economic Policy Coordination, (eds.) Willem H. Buiter and Richard C. Marston,
139-178, Cambridge University Press (1985).
m. 7.
International Debt
*
Jeremy Bulow and Kenneth Rogoff, "A Constant Recontracting Model of Sovereign Debt," Journal of
Political Economy 91, (1989).
*
Jeremy Bulow and Kenneth Rogoff, "The Buyback Boondoggle," (October 1988).
*
Jeremy Bulow and Kenneth Rogoff, "Sovereign Debt: Is to Forgive to Forget?" American Economic
Review 79 (1989), 43-50.
Jeremy Bulow and Kenneth Rogoff, "Sovereign Debt Restructurings: Panacea or Pangloss?" NBER WP
2637 (June 1988).
*
Harold L. Cole, James Dow, and William B. English, "Default, Settlement, and Signalling: Lending
Resumption in a Reputational Model of Sovereign Debt," International Economic Review 36(2), May 1995, pp. 365386.
Harold L. Cole and William B. English, "Expropriation and Direct Investment" University of Pennsylvania
(June 1988).
Michael Dooley, "A Retrospective on the Debt Crisis," Ch. 7 in Peter Kenen Understanding
Interdependence, Princeton University Press, 1995, pp. 262-288.