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Portfolio Balance and IS-LM: A Marriage under Fixed Exchange Rates
Stanford University.
1982 (English)Report (Other academic)
Abstract [en]

The past fifteen years has witnessed a thorough reconsideration of the theory of international capital flows and monetary policy in open economies. Much of this work is based on the concept of portfolio balance and stock-flow equilibrium. The present paper develops a tractable way of incorporating portfolio balance into a modified IS-LM model, thereby bringing the much-used framework into line with modern thinking about financial equilibrium under foxed exchange rates. In so doing, the interrelationship between monetary and exchange-market intervention policies is emphasized. This permits a consistent treatment of short-run financial market equilibrium and balance of payments considerations.

To illustrate the usefulness of the resulting "IS-PB" model, a balanced-budget increase in givernment expenditure is examined under alternative monetary stances consistent with the fixed exchange rate. The scant treatment of fiscal policy (relative to monetary and exchange rate policies) in the open-economy portfolio balance literature is thereby partially remedied.

A second application considers the effects of foreign interest rate shocks. The model accurately captures the policy choices facing countries attempting to maintain fixed exchange rates during 1981 when U.S. interest rates were forced up dramatically in an effort to bring inflation under control.

Place, publisher, year, edition, pages
Stockholm: IIES , 1982. , 45 p.
Seminar Paper / Institute for International Economic Studies, Stockholm University, ISSN 0347-8769 ; 207
National Category
URN: urn:nbn:se:su:diva-41436OAI: diva2:330315
Published in connection with a visit at the IIESAvailable from: 2010-07-15 Created: 2010-07-15 Last updated: 2010-07-15

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