Spring 2003 Econ 8510: International Economics I Tue/Thu, 11 am - 12:15 pm Sanford 105

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1 Spring 2003 Econ 8510: International Economics I Tue/Thu, 11 am - 12:15 pm Sanford 105 Instructor: Santanu Chatterjee Office Hours: Tue/Thu 9:30-10:30 am, Brooks 515 Contact: schatt@terry.uga.edu / Course Overview The area of international macroeconomics is one of the most active in macroeconomics. This course surveys some of the recent developments in the field. The course will focus both on real (i.e., non-monetary) and monetary open-economy macro models. There will be three main sources of required readings: Maurice Obstfeld and Kenneth Rogoff, Foundations of International Macroeconomics. The MIT Press, Nelson Mark, International Macroeconomics and Finance: Theory and Econometric Methods. Blackwell Publishers, Gene Grossman and Kenneth Rogoff (eds.), Handbook of International Economics, Volume 3. Elsevier Science B.V., We will also refer to the following book for certain topics: S.J. Turnovsky, International Macroeconomic Dynamics. The MIT Press, In addition, there will be a set of assigned readings for each topic we will discuss. Course Requirements Your final grade will be determined by three factors: (i) Presentation of an assigned article in class, (ii) your participation in class discussions, and (iii) a take-home final examination. The class paper-presentation will carry a weight of 40 percent, discussion and participation will fetch you up to 10 percent, and the take-home final examination will have a weight of 50 percent. The details and requirements for each of the above categories will be described in class. 1

2 Course Outline and Required Readings Approximately, the first half of the course covers real (i.e., non-monetary) openeconomy macro models. For that section of the course, Obstfeld and Rogoff (henceforth referred to as OR ) is the primary text and Nelson Mark (henceforth referred to as NM ) is supplementary. The second half of the course deals with monetary models. Nelson Mark is primary and Obstfeld-Rogoff supplementary for that section. The readings assigned from these two books (on this syllabus) are required. You are also encouraged to read as many of the additional readings listed below as you can. 1. Dynamics of Small Open Economies: OR , ; NM The Real Exchange Rate: OR ; NM 7 3. Uncertainty and International financial markets: OR MonetaryExchange Rate Models: M 1.1, 1.3, 3; OR The Lucas Model: M 4; OR Foreign Exchange Market Efficiency: M 6; OR The Mundell-Fleming Model: M 8; OR New Open-Economy Macroeconomics: M 9; OR Balance-of-Payments Crises: M 11; OR Sovereign Risk: OR Growth in Open Economies: OR International Real Business Cycle Models: OR 7.4; M 5 2

3 Dynamics of Small Open Economies Additional Readings Glick, Reuven and Kenneth Rogoff, 1995, Global versus country-specific productivity shocks and the current account, Journal of Monetary Economics 35, This paper is discussed in Obstfeld and Rogoff in section 2.3. Feldstein, Martin and Charles Horioka, 1980, Domestic savings and international capital flows, Economic Journal 90, This paper is much cited and discussed. Obstfeld, Maurice and Kenneth Rogoff, 1995, The intertemporal approach to the current account, in Gene Grossman and Kenneth Rogoff, (eds.), Handbook of International Economics, vol. 3. Amsterdam: Elsevier. This is an excellent survey, with lots more citations. S.J. Turnovsky, 1997, International Macroeconomic Dynamics. The MIT Press. Chapters 2 and 3 lay out the basic dynamics of small open economies. The Real Exchange Rate Asea, Patrick, and Enrique Mendoza, 1994, The Balassa-Samuelson model: a general equilibrium appraisal, Review of International Economics 2, De Gregorio, Jose; Alberto Giovannini; and, Thomas Krueger, 1994, The behavior of nontradable goods prices in Europe: evidence and interpretation, Review of International Economics 2, Several other interesting papers can be found in this October 1994 special issue on the Balassa-Samuelson model in the Review of International Economics. Dornbusch R., 1987, "Exchange Rates and Prices," American Economic Review, March. Engel, Charles, 1999, Accounting for U.S. real exchange rate changes, Journal of Political Economy 107, This paper has a different view from the first two cited above. Engel, Charles, 2000, Long run PPP may not hold after all, Journal of International Economics 51, Froot, Kenneth A., and Kenneth Rogoff, 1995, Perspectives on PPP and long-run real exchange rates, in Gene Grossman and Kenneth Rogoff, eds., Handbook of International Economics, vol. 3. Elsevier. Goldberg, P. and M. Knetter, "Goods Prices and Exchange Rates: What Have We Learned?" Journal of Economic Literature, September

4 P. Krugman, "Pricing to Market when the Exchange Rate Changes," in S. Arndt and J. Richardson, eds., Real-Financial Linkages among Open Economies. Cambridge: MIT Press, R. Marston, "Real Exchange Rates and Productivity Growth in the United States and Japan," in S. Arndt and J. Richardson, eds., Real-Financial Linkages among Open Economies. Cambridge: MIT Press, M. Obstfeld, "Intertemporal Price Speculation and the Optimal Current-Account Deficit," Journal of International Money and Finance, August ["Reply and Clarification," JIMF, February 1996.] K. Rogoff, "The Purchasing Power Parity Puzzle," Journal of Economic Literature, June Uncertainty and Financial Markets Here are a few papers that construct international models with complete markets, and discuss the correlation of consumption and output. Backus, David K.; Patrick J. Kehoe; and Finn E. Kydland, 1992, International real business cycles, Journal of Political Economy 100, Backus, David K.; Patrick J. Kehoe; and Finn E. Kydland, 1995, International business cycles: Theory and evidence, in Thomas F. Cooley, (ed.), Frontiers of Business Cycle Research (Princeton). Devereux, Michael B.; Allan Gregory; and Gregor W. Smith, 1992, Realistic crosscountry consumption correlations in a two-country equilibrium business-cycle model, Journal of International Money and Finance 11, Baxter, Marianne and Mario J. Crucini, 1995, Business cycles and the asset structure of foreign trade, International Economic Review 36, This paper shows how restricted asset markets can help explain consumption and output correlations. Here are a couple of papers that try to explain the countercyclical movement of the trade balance: Mendoza, Enrique, 1991, Real business cycles in a small open economy, American Economic Review 81, Backus, David P.; Patrick J. Kehoe and Finn E. Kyldnad, 1994, Dynamics of the trade balance and the terms of trade: The J-curve?, American Economic Review 84,

5 Lewis, Karen, 1996, What can explain the apparent lack of international consumption risk sharing? Journal of Political Economy 104, This is an empirical study of the consumption and income correlation puzzle. Lucas, Robert E., 1982, Interest rates and currency prices in a two-country world, Journal of Monetary Economics 10, A lot of the insights about international asset pricing stem from this seminal paper, which we will return to later in the semester. Here are some empirical papers that document the home bias in asset holdings: French, Kenneth R., and James M. Poterba, 1991, Investor diversification and international equity markets, American Economic Review 81, Tesar, Linda L. and Ingrid Werner, 1995, Home bias and high turnover, Journal of International Money and Finance 14, Lewis, Karen K., 1995, Puzzles in international financial markets, in Gene M. Grossman and Kenneth Rogoff, eds., Handbook of International Economics, vol. 3 (Amsterdam: Elsevier). This is a good survey of the home-bias puzzle. Lewis, Karen K., 1999, Trying to explain home bias in equities and consumption, Journal of Economic Literature 37, This paper connects the home-bias puzzle and the consumption-correlation puzzle. Obstfeld, Maurice, and Kenneth Rogoff, 2000, The six major puzzles in international macroeconomics: is there a common cause?, NBER Macro Annual 2000, This paper offers a potential explanation for several of the above puzzles. Monetary Exchange Rate Models These two articles are two of the earliest that model the exchange rate in a monetary, rational expectations environment (assuming flexible goods prices): Frenkel, Jacob, 1976, A monetary approach to the exchange rate: Doctrinal aspects and empirical evidence, Scandinavian Journal of Economics 78, Mussa, Michael, 1976, The exchange rate, the balance of payments, and monetary and fiscal policy under a regime of controlled floating, Scandinavian Journal of Economics 78, This paper models money demand in a cash-in-advance framework. (We have already encountered this paper in our discussion of complete markets.): Lucas, Robert E., 1982, Interest rates and currency prices in a two-country world, Journal of Monetary Economics 10,

6 This paper investigates why we have exchange rates and multiple currencies: Kareken, John and Neil Wallace, 1981, The indeterminacy of equilibrium exchange rates, Quarterly Journal of Economics 96, These papers offer some empirical support for the monetary models in the long run: Mark, Nelson, 1995, Exchange rates and fundamentals: Evidence on long-horizon predictability, American Economic Review 85, Chinn, Menzie and Richard Meese, 1995, Banking on currency forecasts: How predictable is change in money? Journal of International Economics 38, Groen, Jan J.J., 2000, The monetary exchange rate model as a long-run phenomenon, Journal of International Economics 52, MacDonald, Ronald and Mark P. Taylor, 1993, The monetary approach to the exchange rate: Rational expectations, long-run equilibrium, and forecasting, International Monetary Fund Staff Papers 40, MacDonald, Ronald and Mark P. Taylor, 1994, The monetary model of the exchange rate: Long-run relationships, short-run dynamics and how to beat a random walk, Journal of International Money and Finance 13, Mark, Nelson, and Donggyu Sul, 2001, Nominal exchange rates and monetary fundamentals: Evidence from a small post-bretton Woods panel, Journal of International Economics 53, This is a survey of empirical work on exchange rates: Frankel, Jeffrey A., and Andrew K. Rose, 1995, Empirical research on nominal exchange rates, in Gene Grossman and Kenneth Rogoff, eds., Handbook of International Economics, vol. 3. This paper summarizes current exchange-rate arrangements and discusses the sense in which fixed exchange rates don t really exist: Obstfeld, Maurice, and Kenneth Rogoff, 1995, The mirage of fixed exchange rates, Journal of Economic Perspectives 9 (Fall), See also the papers from the recent exchange-rate conference in Madison, Wisconsin: 6

7 International Finance and the Foreign-Exchange Risk Premium The following are some of the papers that examine the bias in the forward exchange-rate forecast: Bekaert, Geert, and Robert Hodrick, 1992, Characterizing predictable components in excess returns in equity and foreign exchange markets, Journal of Finance 47, Bekaert, Geert, and Robert Hodrick, 1993, On biases in the measurement of foreign exchange risk premiums, Journal of International Money and Finance 12, Bilson, John, 1981, The "speculative efficiency" hypothesis, Journal of Business 54, Engel, Charles, 1984, Testing for the absence of expected real profits from forward market speculation, Journal of International Economics 17, Hodrick, Robert and Sanjay Srivastava, 1984, An investigation of risk and return in forward foreign exchange, Journal of International Money and Finance 3, Flood, Robert P. and Andrew Rose, 1996, Fixes: Of the forward discount puzzle, Review of Economics and Statistics 78, Two surveys of this area are: Engel, Charles, 1996, The forward discount anomaly and the risk premium: A survey of recent evidence, Journal of Empirical Finance 3, Hodrick, Robert, 1987, The empirical evidence on the efficiency of forward and futures foreign exchange markets (Chur: Harwood). Here are some papers that examine the foreign exchange risk premium in a general equilibrium setting: Bekaert, Geert; Robert J. Hodrick; and David A. Marshall, 1997, The implications of first-order risk aversion for asset market risk premiums, Journal of Monetary Economics 40, Dumas, Bernard, 1994, Partial-equilibrium vs. general-equilibrium models of international capital market equilibrium, in F. van der Ploeg, ed., Handbook of International Macroeconomics (London, Basil Blackwell). Engel, Charles, 1992, On the foreign exchange risk premium in a general equilibrium model, Journal of International Economics 32,

8 The Mundell-Fleming Model These are the classic articles on the Mundell-Fleming-Dornbusch model: Fleming, J. Marcus, 1962, Domestic financial policies under fixed and under floating exchange rates, IMF Staff Papers 9, Mundell, Robert A., 1968, Capital Mobility and Stabilization Policy under Fixed and Flexible Exchange Rates. Chapter 18 of International Economics, New York: Macmillan, pp Mundell, Robert, 1964, A reply: Capital mobility and size, Canadian Journal of Economics and Political Science 30, Dornbusch, R., 1976, Expectations and Exchange Rate Dynamics. Journal of Political Economy 84(6), Richard Clarida and Jordi Gali. Sources of Real Exchange-Rate Fluctuations: How Important are Nominal Shocks? Carnegie-Rochester Conference Series on Public Policy, 41, 1994, pp Some papers that extended the Dornbusch framework are: Mussa, Michael, 1982, A model of exchange rate dynamics, Journal of Political Economy 90, Mussa, Michael, 1984, The theory of exchange rate determination, in John F.O. Bilson and Richard C. Marston, eds., Exchange Rate Theory and Practice (Chicago). Obstfeld, Maurice, and Kenneth Rogoff, 1984, Exchange rate dynamics with sluggish prices under alternative price-adjustment rules, International Economic Review 25, Empirical examinations of the Dornbusch model: Frankel, Jeffrey, 1979, On the mark: A theory of floating exchange rates based on real interest differentials, American Economic Review 69, Meese, Richard, and Kenneth Rogoff, 1983, Empirical exchange rate models of the seventies: Do they fit out of sample? Journal of International Economics 14, Engel, Charles and Jeffrey Frankel, 1984, Why interest rates react to money announcements: An explanation from the foreign exchange market, Journal of Monetary Economics 13,

9 Meese, Richard, and Kenneth Rogoff, 1988, Was it real? The exchange rate interest differential relation over the modern floating-rate period, Journal of Finance 43, Empirical evidence on price stickiness: Mussa, Michael, 1986, Nominal exchange rate regimes and the behavior of real exchange rates: Evidence and implications, Carnegie-Rochester Series on Public Policy 25, Engel, Charles, 1993, Real exchange rates and relative prices: An empirical investigation, Journal of Monetary Economics 32, Engel, Charles and John H. Rogers, 1996, How wide is the border? American Economic Review 86, Engel, Charles, 1999, Accounting for U.S. real exchange rate changes, Journal of Political Economy 107, Parsley, David C., and Shang-Jin Wei, 2001, Explaining the border effect: the role of exchange rate variability, shipping costs, and geography, Journal of International Economics 55, Some other empirical papers: Campbell, John and Richard Clarida, 1987, The dollar and real interest rates: An empirical investigation, in K. Brunner and A. Meltzer, eds., Carnegie-Rochester Series on Public Policy 27: Eichenbaum, Martin, and Charles Evans, 1995, Some empirical evidence on the effects of shocks to monetary policy on exchange rates, Quarterly Journal of Economics 110, Evans, Martin D.D., and Richard K. Lyons, 1999, Order flow and exchange rate dynamics, NBER working paper no. 7317, forthcoming, Journal of Political Economy. Engel, Charles, and James D. Hamilton, 1990, Long swings in the dollar: Are they in the data and do markets know it?, American Economic Review 80 (1990), Flood, Robert and Andrew Rose, 1995, Fixing exchange rates: A virtual quest for fundamentals, Journal of Monetary Economics 36, Frankel, Jeffrey and Kenneth Froot, 1990, Chartists, fundamentalists and the demand for dollars, in A. Courakis and M. Taylor, eds., Private behavior and government policy in interdependent economies (Oxford, Clarendon Press). 9

10 Lyons, Richard K., 1997, A simultaneous trade model of the foreign exchange hot potato, Journal of International Economics 42, New Open Economy Macroeconomics Bergin, Paul R., and Robert C. Feenstra, 1999, Pricing to market, staggered contracts, and real exchange rate persistence, NBER working paper no Betts, Caroline, and Michael B. Devereux, 1996, The exchange rate in a model of pricing to market, European Economic Review 40, Betts, Caroline, and Michael B. Devereux, 2000, Exchange rate dynamics in a model of pricing to market, Journal of International Economics 50, Chari, V.V.; Patrick J. Kehoe; and, Ellen R. McGrattan, 2000, Can sticky price models generate volatile and persistent real exchange rates?, NBER working paper no Corsetti, Giancarlo, and Paolo Pesenti, 1997, Welfare and macroeconomic interdependence, Quarterly Journal of Economics 106, Devereux, Michael B., and Charles Engel, 2000, Monetary Policy in the open economy revisited: price setting and exchange-rate flexibility, NBER working paper no Engel, Charles, 1999, On the foreign exchange risk premium in sticky-price general equilibrium models, in P. Isard, A. Razin and A.K. Rose, eds., International Finance and Financial Crises: Essays in Honor of Robert P. Flood, Jr. (Boston; Kluwer). Lane, Philip R., 2001, The new open economy macroeconomics: A survey, Journal of International Economics 54, Obstfeld, Maurice, International macroeconomics: beyond the Mundell-Fleming model, NBER working paper Obstfeld, Maurice, and Kenneth Rogoff, 1995, Exchange rate dynamics redux, Journal of Political Economy 103, Obstfeld, Maurice, and Kenneth Rogoff, 1998, Risk and exchange rates, NBER working paper no Obstfeld, Maurice, and Kenneth Rogoff, 2000, New directions for stochastic open economy models, Journal of International Economics 50,

11 Balance of Payments Crises (1st and 2nd generation): These are the basic readings on balance-of-payments-crises: Krugman, Paul, 1979, A model of balance of payment crises, Journal of Money, Credit and Banking 11, Flood, Robert P. and Peter M. Garber, 1984, Collapsing exchange rate regimes: Some linear examples, Journal of International Economics 17, Obstfeld, Maurice, 1984, Balance of payments crises and devaluation, Journal of Money, Credit and Banking 16, Obstfeld, Maurice, 1986, Rational and self-fulfilling balance of payments crises, American Economic Review 76, Obstfeld, Maurice, 1996, Models of currency crises with self-fulfilling features, European Economic Review 40, Eichengreen, Barry and Charles Wyplosz, 1993, The unstable EMS, Brookings Papers on Economic Activity 1, Some other papers: Eichengreen, Barry; Andrew Rose; and, Charles Wyplosz, 1996, Contagious currency crises: First tests, Scandinavian Journal of Economics 98, Jeanne, Olivier, 1997, Are currency crises self-fulfilling? A test, Journal of International Economics 43, pages Krugman, Paul, 1996, Are currency crises self-fulfilling?, NBER Macroeconomics Annual 1996, Obstfeld, Maurice, 1986, Speculative attack and the external constraint in a maximizing model of the balance of payments, Canadian Journal of Economics 19, Sachs,Jeffrey D.; Aaron Tornell; and, Andres Velasco, 1996, The Mexican peso crisis: Sudden death or death foretold?, Journal of International Economics 41,

12 Sovereign Risk Here are four influential papers: Atkeson, Andrew, 1991, International lending with moral hazard and risk of repudiation, Econometrica 59, Bulow, Jeremy, and Kenneth Rogoff, 1989, A constant recontracting model of sovereign debt, Journal of Political Economy 97, Eaton, Jonathan and Mark Gersovitz, 1981, Debt with potential repudiation: Theory and estimation, Review of Economic Studies 30, Kletzer, Kenneth M., 1984, Asymmetries of information and LDC borrowing with sovereign risk, Economic Journal 94, Two excellent surveys are: Kletzer, Kenneth M., 1994, Sovereign immunity and international lending, in Frederick van der Ploeg, ed., The Handbook of International Macroeconomics (Oxford: Basil Blackwell). Eaton, Jonathan, and Raquel Fernandez, 1995, Sovereign debt, in Gene M. Grossman and Kenneth Rogoff, eds., Handbook of International Economics, vol. 3 (Amsterdam: Elsevier). Growth in a Small Open Economy Baldwin, R.E., and R. Forslid, 1999, Incremental Trade Policy and Endogenous Growth: A q-theory approach, Journal of Economic Dynamics and Control 23, Barro, R., N.G. Mankiw, and X. Sala-i-Martin, 1995, Capital mobility in neoclassical models of growth, American Economic Review 85, Eicher, T.S., and S.J. Turnovsky, 1999, International capital markets and non-scale growth, Review of International Economics 7, S.J. Turnovsky, International Macroeconomic Dynamics, Chapter 5, MIT Press, International Real Business Cycle Models Backus, David, Patrick J. Kehoe, and Finn E. Kydland, International Real Business Cycles, Journal of Political Economy, 100 August 1992, pp Baxter, Marianne, International Trade and Business Cycles, in in G.M. Grossman and K. Rogoff, eds., Handbook of International Economics, vol. 3, chapter