OPEN ECONOMY MACROECONOMICS (Humboldt University, Winter Semester 2005-6)

Course information The course will cover the main topics in modern open economy macroeconomics, with a particular emphasis on monetary economics issues. We will start with some key concepts and definitions in order to understand what makes an open economy fundamentally different from a closed economy. A simple toy-model will help us develop the basic economic intuitions behind the intertemporal consumptionsaving decisions of economic agents under alternative international financial markets arrangements. Building on a fully fledged intertemporal model, we will then study issues such as the transmission of foreign shocks (e.g. interest rates, productivity, inflation), current account dynamics, nominal and real exchange rate determination, as well as the Dornbuschs overshooting hypothesis. We will then move to a very much debated issue in emerging markets economies: inflation stabilization. Through some rigorous models, we will compare the real effect of temporary versus permanent exchange-rate-based stabilization programs (as those observed in Latin America, for instance), talk about currency substitution and the timeinconsistency of fixed exchange rate regimes. The imperfect credibility of stabilization programs will finally bring us to the last topic: currency crises (sometimes also called, balance of payments crises). We will analyze in details the alternative explanations brought forward in the last few years, namely the possible inconsistency between fiscal and monetary policies, the self-fulfilling expectations hypothesis and the currency-mismatch in corporate balance sheets. Lectures Handouts covering the key elements of each lecture will be posted on the courses website before each class. Part I: Introduction Key concepts and definitions A simple 2-period model under alternative international financial markets arrangements

Key References: Ch.1 in Obstfeld and Rogoff (2002) Part II: The intertemporal approach to current accounts The standard intertemporal growth model in an open economy

The effects of unanticipated temporary and permanent shocks to productivity, interest rates, etc A brief introduction to what drives real business cycles in open economies

Key References: Ch. 2 in Obstfeld and Rogoff (2002), Obstfeld and Rogoff (1995) Part III: A dynamic model of exchange rate determination The basic intuition of nominal exchange rate determination: the Cagan model A standard infinite horizon monetary model for open economies Nominal exchange rate determination in a flexible price economy Dornbuschs overshooting hypothesis in a sticky price economy A fiscal theory of nominal exchange rate determination Key References: Ch. 8-9 in Obstfeld and Rogoff (2002), Daniel (2001) Part IV: Exchange Rate Based Inflation Stabilization Programs Introduction to maximization in continuous time models A standard monetary model with traded and non-traded goods Real dynamics under temporary exchange rate stabilization programs The time inconsistency of fixed exchange rate regimes

Key References On optimization in continuous time: the handouts will be enough. But in alternative you can also check the Appendix in Barro and Sala-i-Martin (2004) or the Appendix in Obstfeld and Rogoff (2002) On stabilization programs: Calvo and Vegh (1999), Calvo (1986), Agenor and Montiel (1996), Velasco (1995) Part V: Currency crises First generation models: a fiscal-monetary policy inconsistency Second generation models: optimizing governments and self-fulfilling currency crises Third generation models: a balance sheet approach to currency crises

Key References General: Krugman (2000) On First Generation Models: Krugman (1979), Flood and Garber (1984), Christiano et al. (2001), Corsetti and Mackowiack (2005) On Second Generation Models: Obstfeld (1996)

On Third Generation Models: Aghion et al. (2000,2001,2003) References Agenor and Montiel (1996), Development Macroeconomics, Princeton University Press. Aghion, Bacchetta and Banerjee (2000), A simple model of monetary policy and currency crises, European Economic Review, 44, 728-738 Aghion, Bacchetta and Banerjee (2001), Currency crises and monetary policy in an economy with credit constraints, European Economic Review, 45, 1121-1150 Barro and Sala-i-Martin (2004), Economic Growth, MIT Press, 2nd Edition. Calvo (1986), Temporary stabilization: predetermined exchange rates, Journal of Political Economy, 94, 1319-1329. Calvo and Vegh (1999), Inflation stabilization and BOP crises in developing countries, Hanbook of Macroeconomics, Vol. C, Edited by Woodford and Taylor. Corsetti and Mackowiack (2005), Fiscal imbalances and the dynamics of currency crises, forthcoming in European Economic Review Christiano, Eichenbaum and Rebelo (2001), Prospective deficits and the Asian currency crisis, Journal of Political Economy, 109, 1155-1197. Daniel (2001), The fiscal theory of the price level in an open economy, Journal of Monetary Economics, 48, 293-308 Flood and Garber (1995), Collapsing exchange rate regimes: some linear examples, Journal of International Economics, 17, 1-13. Krugman (1979), A model of balance of payments crises, Journal of Money, Credit and Banking, 11, 311-325. Krugman (2000), Currency Crises, NBER Obstfeld (1996), Models of currency crises with self-fulfilling features, European Economic Review, 40, 1037-1047. Obstfeld and Rogoff (1995), The intertemporal approach to the current account, in Handbook of International Economics. Obstfeld and Rogoff (2002), Foundations of International Macroeconomics, MIT Press, 5th Printing. Velasco (1995), Fixed exchange rates: credibility, flexibility and multiplicity, European Economic Review, 40, 1023-1035.