An intertemporal-optimizing general equilibrium model of exchange rates and external imbalances

Attapol Threemonkong

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: This dissertation develops an intertemporal-optimizing general equilibrium model of exchange rates and external imbalances by providing a bridge between recent developments in international finance literature and international trade and policy literature;Using an intertemporal-optimizing general-equilibrium framework, many presumptions of the traditional international finance literature have been overturned; the current account should be viewed as a nation's decision to save or dissave, and therefore must be analyzed in an intertemporal context. Another virtue of macro-models derived from individual optimizing behavior is that the behavioral rules of economic agents are consistent with the performance of the macroeconomic model;The model is one of a small-open economy producing two goods in each of two periods. The government uses trade policy to protect its importable good. Production decisions are made so as to maximize profits. The model is general equilibrium in nature; households are the ultimate owners of the firms and view all production as income. Each household is forward-looking in the sense that it maximizes lifetime utility subject to an intertemporal lifetime budget constraint. All transactions require the use of money so that it is possible to consider the co-movements of the nominal exchange rate and real economic variables;We consider the optimization problems of households and firms. The general equilibrium model is solved. The effects of internal and external macroeconomic disturbances are then considered;Another concern of this dissertation is the consideration of the equivalence of tariffs and quotas. The study shows there is a vector of quotas which is equivalent to any arbitrary tariff vector. Nevertheless, the equivalence breaks down when internal and external economic disturbances are considered;Furthermore, the model exhibits exchange rate and money neutrality. It shows that exchange rate is completely endogenous; co-movements between the nominal exchange rate and other variables in the system cannot be attributed to the exchange rate itself. Moreover, there is no simple relationship between the exchange rate and the other endogenous variables in the system. Therefore, it should not be concluded that the trade imbalance is due to movements in the nominal exchange rate. However, the nation's rate of time preference plays a major role on the trade balance.

Date: 1992-01-01
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