Policy Decentralization and Exchange Rate Management in Interdependent Economies

37 Pages Posted: 12 Feb 2001

See all articles by Willem H. Buiter

Willem H. Buiter

Citigroup New York; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute); Columbia University

Jonathan Eaton

Leonard N. Stern School of Business - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: August 1980

Abstract

The paper provides a theoretical framework for analyzing policy formation among independent authorities operating in an interdependent environment. This is then applied to the analysis of optimal monetary policy in a stochastic two-country model with rational expectations. The main conclusions are 1) Optimal monetary policy requires a finite response of the money supply to the exchange rate (which is the only contemporaneously observed variable.) Neither a fixed nor a freely floating exchange rate is likely to be optimal. 2) Output stabilizing monetary policy may well require 'leaning with the wind' in the foreign exchange market, expanding the money supply when the home currency depreciates, thus increasing the volatility of the exchange rate. 3) The ability of the monetary authorities to influence real variables is due to the assumption that the private sector does not make exchange rate-contingent forward contracts.4) There are likely to be gains from policy coordination.

Suggested Citation

Buiter, Willem H. and Eaton, Jonathan, Policy Decentralization and Exchange Rate Management in Interdependent Economies (August 1980). NBER Working Paper No. w0531. Available at SSRN: https://ssrn.com/abstract=256068

Willem H. Buiter (Contact Author)

Citigroup New York

Citigroup Global Markets Inc
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HOME PAGE: http://willembuiter.com/

Centre for Economic Policy Research (CEPR)

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CESifo (Center for Economic Studies and Ifo Institute)

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HOME PAGE: http://www.CESifo.de

Columbia University ( email )

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Jonathan Eaton

Leonard N. Stern School of Business - Department of Economics ( email )

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212-995-3932 (Fax)

HOME PAGE: http://www.econ.nyu.edu/user/eatonj/

National Bureau of Economic Research (NBER)

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