What to Stabilize in the Open Economy?: Some Notes on a Problem of Keynes

Valerie Bencivenga, Elisabeth Huybens and Bruce Smith
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Elisabeth Huybens: Centro de Investigacion Economica (CIE), Instituto Tecnologico Autonomo de Mexico (ITAM)

No 9709, Working Papers from Centro de Investigacion Economica, ITAM

Abstract: We consider the question of how to "best" maintain price level stability in the open economy and evaluate three possible policy choices: (a) a constant money growth rate rule; (b) a fixed rate: and (c) a policy of explicit commitment to a price lavel target. In each case we assume that policy is conducted by injecting or withdrawing reserves from the "banking system". In evaluating the three regimes, we adopt Keynes´criteria for a desirable policy: the best policy should leave the least scope for indeterminancy and "excessive" economic volatility. In a steady state equilibrium the choice of regime is largely irrelevant: any steady state equilibrium under one regime can be duplicated by an appropriate choice of the "control" variable under any other regime. However, we show that the set equilibria under the three regimes is dramatically different. When all countries follow the policy of fixing a constant rate of money growth, there are no equilibria displaying endogenously arising volatility and, if hyperinflationary equilibria are excluded, there in no indeterminancy of equilibrium. Under a regime of fixed exchange rates, indeterminancies and endogenously arising fluctuations are impossible if the country with the low "reserve deposit ratio" is charged with maintaining the fixed rate. Finally, when one country targets the time path of its price level, under very weak conditions, there will be indeterminancy of equilibrium and endogenously arising volatility driven by expectations.

Pages: 48 pages
Date: 1997-08
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Persistent link: https://EconPapers.repec.org/RePEc:cie:wpaper:9709

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