Note on “economic policy in an open economy under alternative exchange rate systems: Effectiveness and stability in the short and long run”

Abstract

academic year of 1975-76 marked the immergence of the portfolio approach as a major tool in balance of payments analysis. Among other events it saw the publication of major papers by Branson [1976], Scarth [1975], Steinherr [1975] and Turnovsky [1976] which applied this approach to Keynesian payments theory. The last three of these authors deal with the case of capital mobility. Scarth and Turnovsky give detailed descriptions of both momentary equilibrium and a long-run equilibrium in which all asset stocks are constant. These analyses contrast strongly with Steinherr's result that long-run stock equilibrium is impossible in the presence of capital mobility. Since portfolio theory seems likely to become the major tool in this area and since capital mobility is a dominant feature of the world economy it seems important to be clear as to whether there can be stock equilibrium in open economies. The present note argues that Steinherr's result is due to a slip and that there can be stock equilibrium in an open economy with capital mobility. Steinherr's argument is as follows. The government sterilizes s per cent of its payments surplus, Z, and finances g per cent of it's government deficit, D, by selling bonds. Thus, where the stock of money, M, and the stock of bonds, B, are constant one has