Bibliographic record and links to related information available from the Library of Congress catalog.

**Note:** Contents data are machine generated based on pre-publication provided by the publisher. Contents may have variations from the printed book or be incomplete or contain other coding.

Contents Preface to the fifth edition xi Publishers' acknowledgements xiii 1 Introduction 1 Introduction 1 1.1 What is an exchange rate? 3 1.2 The market for foreign currency 14 1.3 Balance of payments 21 1.4 The DIY model 26 1.5 Exchange rates since World War II: a brief history 27 1.6 Overview of the book 37 Summary 38 Reading guide 39 Notes 39 Part I THE INTERNATIONAL SETTING 45 2 Prices in the open economy: purchasing power parity 47 Introduction 47 2.1 The law of one price in the domestic economy 48 2.2 The law of one price in the open economy 55 2.3 A digression on price indices 60 2.4 Purchasing power parity 63 2.5 Purchasing power parity + the facts at a glance 68 2.6 Purchasing power parity extensions 72 2.7 Empirical research 77 2.8 Conclusions 78 Summary 80 Reading guide 81 Notes 82 3 Financial markets in the open economy 85 Introduction 85 3.1 Uncovered interest rate parity 86 3.2 Covered interest rate parity 94 3.3 Borrowing and lending 96 3.4 Covered interest rate parity + the facts 100 3.5 Efficient markets + a first encounter 101 3.6 Purchasing power parity revisited 104 Summary 108 Reading guide 109 Notes 109 4 Open economy macroeconomics 112 Introduction 112 4.1 IS+LM model of aggregate demand 113 4.2 Aggregate supply 134 4.3 Conclusions 140 Summary 141 Reading guide 142 Notes 142 Part II EXCHANGE RATE DETERMINATION 147 5 Flexible prices: the monetary model 149 Introduction 149 5.1 The simple monetary model of a floating exchange rate 150 5.2 The simple monetary model of a fixed exchange rate 158 5.3 Interest rates in the monetary model 167 5.4 The monetary model as an explanation of the facts 169 5.5 Conclusions 173 Summary 173 Reading guide 174 Notes 174 6 Fixed prices: the Mundell+Fleming model 176 Introduction 176 6.1 Setting 177 6.2 Equilibrium 180 6.3 Monetary expansion with a floating exchange rate 181 6.4 Fiscal expansion with a floating exchange rate 182 6.5 Monetary expansion with a fixed exchange rate 184 6.6 Fiscal expansion with a fixed exchange rate 186 6.7 The monetary model and the Mundell+Fleming model compared 187 6.8 Evidence 191 6.9 Conclusions 192 Summary 192 Reading guide 192 Notes 193 7 Sticky prices: the Dornbusch model 195 Introduction 195 7.1 Outline of the model 196 7.2 Monetary expansion 201 7.3 A formal explanation 205 7.4 Oil and the UK economy 209 7.5 Empirical tests: the Frankel model 215 7.6 Conclusions 216 Summary 217 Reading guide 217 Notes 218 8 Portfolio balance and the current account 220 Introduction 220 8.1 Specification of asset markets 221 8.2 Short-run equilibrium 225 8.3 Long-run and current account equilibrium 230 8.4 Evidence on portfolio balance models 232 8.5 Conclusions 236 Summary 236 Reading guide 237 Notes 237 9 Currency substitution 239 Introduction 239 9.1 The model 240 9.2 Evidence on currency substitution 247 9.3 Conclusions 248 Summary 248 Reading guide 249 Notes 249 10 General equilibrium models 252 Introduction 252 10.1 The Redux model 254 10.2 Extensions of Redux 272 10.3 Evidence 275 10.4 Conclusions 276 Summary 277 Reading guide 278 Notes 278 Appendix 10.1: Derivation of price index (Equation 10.2) 280 Appendix 10.2: Derivation of household demand (Equations 10.6 and 10.6¿) 282 Appendix 10.3: Log linearization of model solution (Equations L1+L4) 282 Appendix 10.4: Sticky prices 284 11 Optimum currency areas and monetary union 285 Introduction 285 11.1 Benefits of monetary union 288 11.2 Costs of monetary union 293 11.3 Other considerations 296 11.4 Currency boards 306 11.5 Conclusions 308 Summary 309 Reading guide 310 Notes 310 Part III A WORLD OF UNCERTAINTY 315 12 Market efficiency and rational expectations 317 Introduction 317 12.1 Mathematical expected value 318 12.2 Rational expectations 320 12.3 Market efficiency 324 12.4 Unbiasedness 326 12.5 The random walk model 327 12.6 Testing for efficiency: some basic problems 329 12.7 Spot and forward rates: background facts 330 12.8 Results 332 12.9 Conclusions 335 Summary 336 Reading guide 337 Notes 337 13 The 'news' model and exchange rate volatility 340 Introduction 340 13.1 The 'news' model: a simple example 341 13.2 The monetary model revisited 343 13.3 Testing the 'news' 349 13.4 Results 353 13.5 Volatility tests, bubbles and the peso problem 355 13.6 Conclusions 360 Summary 360 Reading guide 361 Notes 362 14 Microstructure models 364 Introduction 364 14.1 Order flow analysis 365 14.2 Order flow 369 14.3 Microstructural analysis 376 14.4 Conclusions 386 Summary 388 Reading guide 388 Notes 389 15 The risk premium 391 Introduction 391 15.1 Assumptions 392 15.2 A simple model of the risk premium: mean+variance analysis 393 15.3 A general model of the risk premium 396 15.4 Evidence of the risk premium 402 15.5 Conclusions 403 Summary 403 Reading guide 404 Notes 404 Appendix 15.1: Derivation of Equation 15.12 405 16 A certain uncertainty: non-linearity, cycles and chaos 407 Introduction 407 16.1 Deterministic versus stochastic models 408 16.2 A simple non-linear model 409 16.3 Time path of the exchange rate 411 16.4 Chaos 424 16.5 Evidence 429 16.6 Conclusions 433 Summary 435 Reading guide 435 Notes 436 Part IV FIXED EXCHANGE RATES 439 17 Target zones 441 Introduction 441 17.1 What is a target zone? 443 17.2 Effect of target zones 444 17.3 Smooth pasting 448 17.4 An option interpretation 450 17.5 A honeymoon for policymakers? 458 17.6 Beauty and the beast: the target zone model meets the facts 461 17.7 Intramarginal interventions: leaning against the wind 463 17.8 Credibility and realignment prospects 465 17.9 Conclusions 467 Summary 467 Reading guide 468 Notes 469 Appendix 17.1: Formal derivation of the model 470 18 Crises and credibility 472 Introduction 472 18.1 First-generation model 473 18.2 Second-generation crisis models 481 18.3 Third-generation models 490 18.4 Conclusions 496 Summary 496 Reading guide 497 Notes 498 Part V CONCLUSIONS 501 19 Conclusions 503 Introduction 503 19.1 Summary of the book 503 19.2 Where do we go from here? 505 Appendix: list of symbols 508 Bibliography 510 Index 518

Library of Congress Subject Headings for this publication:

Foreign exchange rates.

International finance.