Mohsin S. Khan, Saleh M. Nsouli, and Mr. Chorng-Huey Wong
Since its establishment in 1964, the IMF Institute has trained more than 13,000 officials from 183 member countries in Washington and over 8,000 officials overseas. The training focuses on such subjects as financial programming and policies, monetary and exchange operations, public finance, financial sector issues, and macroeconomic statistics. This book includes some of the background material that the IMF Institute uses in the training of country officials. Although IMF Institute courses also cover structural issues—such as banking system, public enterprises, and labor market reform (which are also critical to the achievement of economic policy objectives), this book deals only with macroeconomic issues. Specifically, it addresses some of the key questions policymakers face in managing national economies:
Traditional models of exchange rate determination have focused on three types of explanatory variables: national price levels, interest rates, and the balance of payments. Although the perception that exchange rates are related to national price levels had existed for a long time, it was with Cassel’s introduction of the term purchasing power parity (PPP) in 1918 that exchange rates became closely associated with the comparative purchasing powers of national currencies. Policymakers were also aware that the behavior of exchange rates could be influenced by adjustments in interest rates: when interest rates rise, the exchange rate—the price of foreign currency in terms of domestic currency—falls, indicating an appreciation, or strengthening, of the domestic currency. The relationship between the interest rate and the exchange rate—known as the interest rate parity hypothesis—was bolstered as forward exchange markets developed. The recognition that exchange rates adjust to international payments established a relationship between the exchange rate and the balance of payments. With the Keynesian revolution and the rapid expansion of international capital transactions related to international trade, however, the behavioral links between the balance of payments and the exchange rate were reexamined and embedded in models that took into account the interplay of external and internal pressures on exchange rates.