Preface and acknowledgements
1 Introduction
Introduction
1.1 What is an exchange rate?
1.2 The market for foreign currency
1.3 The balance of payments
1.4 The DIY model
1.5 Exchange rates since World War II: a brief history
1.6 Overview of the book
Summary
Reading guide
Notes
Part 1
THE INTERNATIONAL SETTING
2 Prices in the open economy: purchasing power parity
Introduction
2.1 The law of one price in the domestic economy
2.2 The law of one price in the open economy
2.3 A digression on price indices
2.4 Purchasing power parity
2.5 Purchasing power parity - the facts at a glance
2.6 Purchasing power parity extensions
2.7 Empirical research
2.8 Conclusions
Summary
Reading guide
Notes
3 Financial markets in the open economy
Introduction
3.1 Uncovered interest rate parity
3.2 Covered interest rate parity
3.3 Borrowing and lending
3.4 Covered interest rate parity - the facts
3.5 Efficient markets - a first encounter
3.6 The carry trade paradox
3.7 Purchasing power parity revisited
Summary
Reading guide
Notes
4 Open economy macroeconomics
Introduction
4.1 IS-LM model of aggregate demand
4.2 Aggregate supply
4.3 Conclusions
Summary
Reading guide
Notes
Part 2
EXCHANGE RATE DETERMINATION
5 Flexible prices: the monetary model
Introduction
5.1 The simple monetary model of a floating exchange rate
5.2 The simple monetary model of a fixed exchange rate
5.3 Interest rates in the monetary model
5.4 The monetary model as an explanation of the facts
5.5 Conclusions
Summary
Reading guide
Notes
6 Fixed prices: the Mundell-Fleming model
Introduction
6.1 Setting
6.2 Equilibrium
6.3 Monetary expansion with a floating exchange rate
6.4 Fiscal expansion with a floating exchange rate
6.5 Monetary expansion with a fixed exchange rate
6.6 Fiscal expansion with a fixed exchange rate
6.7 The monetary model and the Mundell-Fleming model compared
6.8 Evidence
6.9 Conclusions
Summary
Reading guide
Notes
7 Sticky prices: the Dornbusch model
Introduction
7.1 Outline of the model
7.2 Monetary expansion
7.3 A formal explanation
7.4 Case study: oil and the UK economy
7.5 Empirical tests: the Frankel model
7.6 Conclusions
Summary
Reading guide
Notes
8 Portfolio balance and the current account
Introduction
8.1 Specification of asset markets
8.2 Short-run equilibrium
8.3 Long-run and current account equilibrium
8.4 Evidence on portfolio balance models
8.5 Conclusions
Summary
Reading guide
Notes
9 Currency substitution
Introduction
9.1 The model
9.2 Evidence on currency substitution
9.3 Conclusions
Summary
Reading guide
Notes
10 General equilibrium models
Introduction
10.1 The Redux model
10.2 Extensions of Redux
10.3 Evidence
10.4 Conclusions
Summary
Reading guide
Notes
Appendix 10.1: Derivation of price index (Equation 10.2)
Appendix 10.2: Derivation of household demand (Equations 10.6 and 10.6')
Appendix 10.3: Log linearisation of model solution (Equations L1-L4)
Appendix 10.4: Sticky prices
Part 3
A WORLD OF UNCERTAINTY
11 Market efficiency and rational expectations
Introduction
11.1 Mathematical expected value
11.2 Rational expectations
11.3 Market efficiency
11.4 Unbiasedness
11.5 The random walk model
11.6 Testing for efficiency: some basic problems
11.7 Spot and forward rates: background facts
11.8 Results
11.9 Conclusions
Summary
Reading guide
Notes
12 The 'news model, exchange rate volatility and forecasting
Introduction
12.1 The 'news model: a simple example
12.2 The monetary model revisited
12.3 Testing the 'news
12.4 Results
12.5 Volatility tests, bubbles and the peso problem
12.6 Conclusions
Summary
Reading guide
Notes
13 The risk premium
Introduction
13.1 Assumptions
13.2 A simple model of the risk premium: mean-variance analysis
13.3 A general model of the risk premium
13.4 The evidence on the risk premium
13.5 Conclusions
Summary
Reading guide
Notes
Part 4
FIXED EXCHANGE RATES
14 Target zones
Introduction
14.1 What is a target zone
14.2 Effect of target zones
14.3 Smooth pasting
14.4 An option interpretation
14.5 A honey moon for policymakers?
14.6 Beauty and the beast: the target zone model meets the facts
14.7 Intramarginal interventions: leaning against the wind
14.8 Credibility and realignment prospects
14.9 Conclusions
Summary
Reading guide
Notes
Appendix 14.1: Formal derivation model
15 Crises and credibility
Introduction
15.1 First-generation model
15.2 Second-generation crisis models
15.3 Third-generation models
15.4 The 2008 crisis
15.5 Conclusions
Summary
Reading guide
Notes
16 Optimum currency areas, monetary union and the eurozone
Introduction
16.1 Benefits of monetary union
16.2 Costs of monetary union
16.3 Other considerations
16.4 Currency bonds
16.5 The eurozone
16.6 Conclusions
Summary
Reading guide
Notes
Part 5
ALTERNATIVE PARADIGMS
17 Heterogeneous expectations and scapegoat models
Introduction
17.1 The market maker model
17.2 Introduction to expectations with heterogeneous information
17.3 Conclusions
Summary
Reading guide
Notes
Appendix 17.1 :
A. Derivation of the first-order condition for money (Equation 17.36)
B. Derivation of the first-order condition for foreign bonds (Equation 17.37)
C. Proof of the solution for the exchange rate (Equation 17.43)
D. Proof that Equation 17.50 is the solution for Equation 17.49
18 Order flow analysis
Introduction
18.1 The structure of the foreign currency market
18.2 Defining order flow
18.3 Fear of arbitrage, common knowledge and the hot potato
18.4 The pricing process
18.5 Empirical studies of order flow
18.6 Conclusions
Summary
Reading guide
Notes
19 A certain uncertainty: nonlinearity, cycles and chaos
Introduction
19.1 Deterministic versus stochastic models
19.2 A simple nonlinear model
19.3 Time path of the exchange rate
19.4 Chaos
19.5 Evidence
19.6 Conclusions
Summary
Reading guide
Notes
Part 6
CONCLUSIONS
20 Conclusions
Introduction
20.1 Summary of the book
20.2 The research agenda
Notes
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