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Real effects of monetary policy in a world economy

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  • Preston J. Miller
  • Richard M. Todd

Abstract

We present a 2-country model with heterogeneous agents in which changes in a country?s monetary policy affect real interest rates, relative prices of traded and nontraded goods and real exchange rates. Nontransitory real effects of monetary policy stem solely from a friction (country-specific reserve requirements) that generates separate demands for a country?s money and bonds. Without violating the classical assumptions of individual rationality and flexible prices, the model?s implications seem qualitatively in accord with the U.S. experience of the 1980s: a monetary policy tightening leading to a rise in the real interest rate and to an initial rise in the real value of the dollar which is subsequently reversed. In the model a monetary policy change leads to different welfare effects for agents born at different times, living in different countries, or participating on different sides of a market. The welfare of some agents can be affected more by relative price changes than by real interest rate changes.

Suggested Citation

  • Preston J. Miller & Richard M. Todd, 1992. "Real effects of monetary policy in a world economy," Staff Report 154, Federal Reserve Bank of Minneapolis.
    • Handle: RePEc:fip:fedmsr:154
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    References listed on IDEAS

    as
    1. Preston J. Miller, 1982. "Fiscal policy in a monetarist model," Staff Report 67, Federal Reserve Bank of Minneapolis.
    2. David Orden, 1986. "A Critique of Exchange Rate Treatment in Agricultural Trade Models: Comment," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 68(4), pages 990-993.
    3. Aizenman, Joshua, 1983. "A theory of current account and exchange rate determinations," European Economic Review, Elsevier, vol. 23(3), pages 261-280, September.
    4. Thomas J. Sargent & Neil Wallace, 1984. "Some Unpleasant Monetarist Arithmetic," Palgrave Macmillan Books, in: Brian Griffiths & Geoffrey E. Wood (ed.), Monetarism in the United Kingdom, pages 15-41, Palgrave Macmillan.
    5. Miller, Preston J & Roberds, William T, 1991. "The Quantitative Significance of the Lucas Critique," Journal of Business & Economic Statistics, American Statistical Association, vol. 9(4), pages 361-387, October.
    6. Preston J. Miller & Neil Wallace, 1985. "International coordination of macroeconomic policies: a welfare analysis," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 9(Spr).
    7. Jeremy Greenwood, 1984. "Non-traded Goods, the Trade Balance, and the Balance of Payments," Canadian Journal of Economics, Canadian Economics Association, vol. 17(4), pages 806-823, November.
    8. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-1176, December.
    9. Orden, David, 2002. "Exchange Rate Effects on Agricultural Trade," Journal of Agricultural and Applied Economics, Cambridge University Press, vol. 34(2), pages 303-312, August.
    10. Ayse Imrohoroglu & Edward C. Prescott, 1991. "Evaluating the welfare effects of alternative monetary arrangements," Quarterly Review, Federal Reserve Bank of Minneapolis, vol. 15(Sum), pages 3-10.
    11. Rotemberg, Julio J., 1985. "Money and the terms of trade," Journal of International Economics, Elsevier, vol. 19(1-2), pages 141-160, August.
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    13. Blanchard, Olivier J, 1984. "The Lucas Critique and the Volcker Deflation," American Economic Review, American Economic Association, vol. 74(2), pages 211-215, May.
    14. Miller, Preston J & Roberds, William T, 1991. "The Quantitative Significance of the Lucas Critique: Reply," Journal of Business & Economic Statistics, American Statistical Association, vol. 9(4), pages 389-389, October.
    15. R. Dornbusch, 1975. "Exchange Rate Dynamics," Working papers 167, Massachusetts Institute of Technology (MIT), Department of Economics.
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    Cited by:

    1. Miller, Preston J. & Todd, Richard M., 1995. "Real effects of monetary policy in a world economy," Journal of Economic Dynamics and Control, Elsevier, vol. 19(1-2), pages 125-153.
    2. Geza, Paula & Giurca Vasilescu, Laura, 2011. "Bretton Woods Fixed Exchange Rate System versus Floating Exchange Rate System," MPRA Paper 29932, University Library of Munich, Germany.
    3. Daniel M. Chin & Preston J. Miller, 1995. "Fixed vs. floating exchange rates: a dynamic general equilibrium analysis," Staff Report 194, Federal Reserve Bank of Minneapolis.
    4. Chin, Daniel M. & Miller, Preston J., 1998. "Fixed vs. floating exchange rates: A dynamic general equilibrium analysis," European Economic Review, Elsevier, vol. 42(7), pages 1221-1249, July.

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