Exchange rate expectations and monetary policy

The adjustment process to a monetary disturbance is studied in a model of perfect capital mobility and flexible exchange rates. Exchange rate expectations are emphasized and used to establish an adjustment process. In the short run, a monetary expansion gives rise to a depreciation in the exchange rate and a reduction in saving due to the terms of trade deterioration. The exchange rate depreciation, in the short run, may be in excess of the long-run depreciation. The trade balance in the short run may worsen. The long-run equilibrium of the analysis conforms to the Mundell-Fleming results that establish the force of monetary policy under flexible rates.     

Lessons from Experiences with High Inflation

In economies where price control has been the rule, the mostserious concern may be recognition of the inflation problem.Beyond the initial correction of subsidies there is the broaderissue of the risk of a serious inflation. This article looksat the problem of high inflation in developing countries inEurope and Latin America and draws lessons from historical experience.It analyzes the dynamics of the interaction among deficit finance,institutional innovation in financial markets, dollarization,and the shortening of wage contracts in high-inflation situations.When stabilization is undertaken, there is neither immediate,spontaneous resumption of longer adjustment periods for wagesand prices nor instant increase of real money demand to noninflationarylevels. Incomes policy—freezing exchange rates, wages,and prices—is advocated as an effective supplement tothe inevitable budget cut to make up for institutional inertiaand facilitate the start of the stabilization process.     

Contagion: Understanding How It Spreads

Much of the current debate on reforming the international financialarchitecture is aimed at reducing the risks of contagion—bestdefined as a significant increase in cross-market linkages aftera shock to an individual country (or group of countries). Thisdefinition highlights the importance of other links throughwhich shocks are normally transmitted, including trade and finance.During times of crisis, the ways in which shocks are transmitteddo seem to differ, and these differences appear to be important.Empirical work has helped to identify the types of links andother macroeconomic conditions that can make a country vulnerableto contagion during crisis periods, although less is known aboutthe importance of microeconomic considerations and institutionalfactors in propagating shocks. Empirical research has helpedto identify those countries that are at risk of contagion aswell as some, albeit quite general, policy interventions thatcan reduce risks.