A Walrasian approach to international adjustment with diversified currency holdings
Breece, James H. “A Walrasian approach to international adjustment with diversified currency holdings”, Boston College, 1982. http://hdl.handle.net/2345/45.
This study investigates the international adjustment process for monetary policy in a two-country, two-asset, Walrasian model with diversified currency holdings. It is assumed that both countries consume both commodities and desire to hold both currencies in order to maximize a money services function. The investigation of the flexible exchange rate regime concludes that the relative rate of change of each currency supply is responsible for determining the rate of change of the exchange rate and prices and that the distribution of currencies between countries is responsible for determining the balance of trade and the terms of trade. The investigation of the fixed exchange rate regime demonstrates that even with the gross substitute assumption, a devaluation will no longer guarantee an improvement in the balance of trade, and that the terms of trade is influenced by the relative rate of change of each currency as well as by the exchange rate. The investigation of the inflationary pressures from a devaluation concludes that as long as the home country's consumption patterns are highly sensitive to changes in the exchange rate, then a devaluation will be more inflationary to the home country in a world with diversified currency holdings than in a world without diversified currency holdings. This study shows that regardless of the exchange rate regime, the introduction of positive cross currency holdings tends to force the effectiveness of changes in monetary policy on changes in prices, balance of trade and the terms of trade to yield results that fall between the traditional flexible exchange rate regime and the traditional fixed exchange rate regime. In addition, the longrun analysis concludes that the familiar Monetarist Theorems are appropriate in explaining longrun monetary adjustment.