The Euro-Dollar Deposit Multiplier: A Note

International Monetary Fund. Research Dept.
Published Date:
January 1975
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This note is a fuller comment on the derivation and estimation of the multiplier in the paper by the same authors, entitled, “The Euro-Dollar Deposit Multiplier: A Portfolio Approach,” which appeared in Staff Papers, Vol. 21 (July 1974) pp. 307–28. In that paper the value of the multiplier was estimated on the assumption that the U.S. balance of payments deficit was insensitive to changes in the Euro-dollar interest rate (that is, it was assumed that BUSrED=0). Although it was pointed out in the paper that this assumption would lead to an overestimate of the value of the multiplier and would make the value of the multiplier extremely sensitive to the value of cd (the ratio of central bank deposits in the market to their total foreign reserves), it was not possible to provide an estimate of the interest elasticity of U. S. balance of payments at that time.

Subsequent work has now provided an estimate of this interest sensitivity. Its importance encourages the authors to re-estimate the value of the multiplier incorporating the new information. In addition, the authors wish to take the opportunity to discuss the mechanism by which the U. S. balance of payments deficit enters the expression for the multiplier. In general, the adjusted estimate of the multiplier reinforces the authors’ general conclusion of the inappropriateness of a “multiplier” concept for the analysis of the Euro-currency market—namely, that deposit multiplication has not been, nor is it potentially, a significant factor in the expansion of these markets.

It should be recalled that the expression for the multiplier was derived in the July 1974 article as:

To appreciate the properties of the multiplier expression, equation (1) can be transformed as:



and since

is positive because

the value of the multiplier (M) is bounded below by M(cd=0) and above by M(cd=1).

Given the estimated values of the partial derivatives of the loan and deposit functions (with appropriate scaling) 1 reported in the July 1974 paper, together with the new estimate of the interest sensitivity of the U.S. balance of payments2 the bounds of the multiplier are estimated as:3

0.63 ≤ M ≤ 1.61

In particular, given the previous estimate of the marginal cd as 0.66, the value of the multiplier would be:

Finally, it should be noted that, in deriving the expression for the multiplier, the shift parameter λ (that is, an exogenous shift of deposits from the U.S. to the Euro-dollar market) is added to both the Di and BUS. The justification for this can be seen from the following identity for the overall U.S. balance of payments deficit:

where BB¯=accumulated U.S. basic balance deficit
NUSE=net U.S. position in short-term capital vis-à-vis European residents excluding Euro-banks
DUS=U.S. deposits with Euro-banks
LUS=U.S. borrowing from Euro-banks

Since BB¯ can be assumed to be exogenous and since the shift parameter λ does not initially affect either LUS or NUSE,

This is not to say, of course, that the final balance of payments effect of this shift will be unity, for subsequent portfolio adjustments to changes in relative interest rates will determine the final effect of this shift on the U.S. balance of payments.


Floating Exchange Rates, Asymmetrical Intervention, and the Management of International Liquidity 1

J. Marcus Fleming

In this paper it is argued that in a system of widespread managed floating, as in a par value system with occasional floating, the problem of asymmetry of adjustment as between the issuers of the principal intervention currencies and other countries and the problem of ensuring an effective international management of reserves remain to be solved. If the latter problem is less acute under a floating system, the former problem is potentially more acute than under par values.

It is argued that under floating rates as under par values, the best solutions for these problems involve a combination of three elements: organized multicurrency intervention, asset settlement, and an SDR substitution account. A development of the system of SDR designation would also be required.

While widespread floating would appear to offer no particular obstacle to the operation of a substitution account, its effect on the acceptability of asset settlement is debatable and it would add considerably to the difficulties of organizing multicurrency intervention. The difficulty of organizing multicurrency intervention under a floating rate system arises from the absence of clear criteria as to which currencies should be bought and sold in intervention and in what quantities they should be bought and sold.

If politically acceptable, a system of guided intervention oriented to an established system of normal exchange rate zones would probably be superior to any other arrangement under floating for the purpose of promoting symmetry in adjustment, while permitting an adequate degree of exchange rate management and avoiding the anomaly of mutually offsetting intervention.

Sharing the Oil Deficit2

Andrew D. Crockett and Duncan Ripley

It is clear that a number of major oil exporting countries will continue to have large structural surpluses in their balances of payments on current account for a number of years to come, and also that these surpluses will be matched by capital outflows. If the adjustment process is to operate smoothly, however, the aggregate surplus of these countries must be reflected in a pattern of current account deficits in the rest of the world which is both acceptable to the individual countries concerned and capable of being financed by sustainable capital inflows.

This paper approaches the optimal sharing of the oil deficit by considering where capital should or is likely to flow. It discusses some of the economic considerations relevant to an optimal and sustainable pattern of capital flows over the medium term, and five distributional schemes are presented, individually and in combination. These five distributive schemes are based on: (1) the effect of the oil price increases on countries’ trade balances; (2) levels of GNP; (3) levels of capital formation; (4) levels of domestic savings; and (5) the size of countries’ export sectors. The relevance of these schemes for optimal capital flows depends, inter alia, on the extent to which increased savings in the oil exporting countries are expected to be reflected either in real capital formation or in a fall in savings in the rest of the world.

Comparisons between the expected pattern of capital movements and the initial pattern of oil deficits are presented as a focus for further discussion. The substantial differences between these patterns underscores the need for agreement on how best to share the oil deficit if the adjustment process is to operate smoothly.

Monetary and Exchange Rate Policies in a Small Open Economy 1

Vicente Galbis

This paper first presents succinctly the theory of monetary and exchange rate policies for a small open economy under both fixed and flexible exchange rates, as developed by Mundell and others, and then expounds on some neglected aspects of these policies in a floating rate system and on the effects of capital controls under both fixed and flexible exchange rates. The assumptions are cast in a Keynesian-type model that can be adapted easily to the fixed or floating exchange rate systems and with or without capital controls.

Monetary policy has no effect on income under a fixed exchange rate but regains full leverage under a pure float; the opposite effect is found with regard to fiscal policy. However, the conclusions derived from the floating rate system are negated when the policymakers form a particular view about the appropriate level of the exchange rate and direct monetary and fiscal policies to maintain it. A hybrid system called the dirty float often emerges to solve these difficulties.

Effective controls of either capital inflows or outflows imply that monetary and fiscal policies will have income effects similar to those of a strictly closed economy, as capital controls eliminate the endogeneity of the monetary base that derives from capital movements. However, the effects from the introduction of, or changes in, capital controls are different under fixed and floating rate systems because in the latter the net change in foreign assets must equal zero.

The Theory of Optimum Currency Areas: A Survey 1

Yoshihide Ishiyama

In view of the asymmetry in the real world, a separate currency and a flexible exchange rate for each country may not be advantageous. What is the appropriate domain of a currency area, then?

The traditional approach tries to single out a certain economic characteristic to answer the question. Proposed criteria include mobility of factors of production, share of tradables in production, product diversification, degree of financial and policy integration, and similarity in rates of inflation.

These criteria have various difficulties. Labor mobility is not an adequate substitute for exchange rate variation in view of the general lack of international mobility; nor is the high share of tradables a compelling reason for having a fixed parity. A fixed parity implies price stability only when world economic environment is stable—an invalid assumption in the 1970s.

An alternative, cost-benefit approach compares benefits of fixed exchange rates—such as the stability of the value of a currency and elimination of speculation—with costs such as the loss of independent monetary policy, the worsening of the unemployment-inflation relationship, and so on. It is suggested that the costs of abandoning an exchange rate policy are very high.

After reviewing various criteria, one would conclude that, despite some academic contributions, the theory of currency areas offers little for solving the practical problems of exchange rate policy in small countries and of monetary reform. Small countries are now becoming increasingly diversified in their trade with large countries. Pegging to a basket of currencies is a more rational policy.

International Aspects of the Taxation of Corporations and Shareholders 2

Mitsuo Sato and Richard M. Bird

This paper systematically analyzes the interaction between recent attempts to integrate the corporate and individual income taxes in several industrial countries and the continuing effort on the part of the same countries to avert international double taxation (or tax avoidance). Four methods of taxing corporate-source income are considered: full integration, the separate entity system, and two forms of partial integration—the split rate system and the imputation system. Recent proposals and discussion in the European Economic Community, France, the United Kingdom, and Canada are considered briefly, with special reference to the role played by international considerations in affecting the final outcome. The implications of these different systems for the achievement of three possible objectives—world efficiency, national efficiency, and inter-country equity—are then considered in detail, with particular attention to the first of these objectives, since it is the one that is usually assumed to underlie such formulations of international tax norms as the model tax treaty of the Organization for Economic Cooperation and Development (OECD).

The analysis shows clearly that the more refined the attempts are to integrate corporate and individual income taxes within a country, the more difficult it becomes to provide equal tax treatment to purely domestic income and income that flows across borders. Even in the simplest case of two countries, each with a separate entity system, the equal fiscal treatment of domestic and international income that is necessary to achieve an efficient allocation of capital among countries requires current taxation (not deferral, as is the usual practice) of all income, with full credit (including refund) for foreign corporation taxes and withholding taxes. If this condition is met, however, the separate entity system is clearly the most conducive of the alternatives considered to international tax neutrality, at least under the standards that normally govern the tax treatment of international income among industrial countries.

The most important of these standards are the nondiscrimination clause and the provision for equal reciprocal withholding tax rates, as embodied, for example, in the OECD model tax treaty and followed in many bilateral treaties. In particular, strict application of the nondiscrimination rule, which prohibits discriminatory treatment of residents and nonresidents, causes substantial difficulties when one country adopts some form of integrated income tax. One way of obviating the resulting problems might be to permit countries to levy withholding tax rates on profit outflows that would lead to effective rather than merely formal equality. In other words, withholding taxes would be varied so as to provide equality, not in the treatment of domestic and foreign investors within one country as is now the case, but in the effective level of taxes on foreign investment income in the two countries, whatever might be the level of tax on the domestic investors in those countries. While there are problems with this effective reciprocity criterion also, it seems essential to alter the prevailing interpretation of international tax rules in some such way in order to avoid the distortion of national decisions on appropriate domestic tax policies that has occurred in recent years.

Dual Markets: The Case of the Syrian Arab Republic 1

Paul M. Dickie and David B. Noursi

The article surveys the performance of the dual exchange market and its contribution to Syria’s overall balance of payments position during the period 1964–71. An econometric model is developed, with explanatory functions for the demand and supply of foreign exchange, together with a function explaining the rate-setting behavior of the Syrian authorities. The model is applied to one major period in the history of the market. Although the items included in the dual market expanded over this period of time, the major transactions that it covered included luxury imports, nontraditional exports and all private capital movements.

The conclusions drawn from the study show that for the period 1964–66 a substantial improvement in Syria’s balance of payments position was achieved with the help of the parallel market. This improvement resulted from an effective devaluation for the items moved to the parallel market and reflects the relatively high export and import elasticities for these items. Other interesting findings include the strong effect of the domestic liquidity variable on the demand for foreign exchange and also the successful rate-setting performance of the Syrian authorities in light of their objectives. Analysis of the subsequent period, during which the dual exchange market was used (1967–71), did not yield any meaningful results because of the use by the authorities of exchange control practices and extensive state trading.

Some Empirical Evidence on the Determinants of Wage and Price Movements in Japan, 1950–73: A Survey2

Ichiro Otani

The purpose of this paper is twofold: (1) to review critically some of the econometric studies on money wages and prices in Japan since World War II; (2) to draw implications about possible incomes or demand management policies to control inflation.

Major issues examined in these studies include the hypothesis that a simultaneous interrelationship exists between wages and prices; the question of the most appropriate proxy variable for demand pressure in the labor market and for the industry’s ability to pay; and the dual structural relationship in the mechanism for wage-price determination.

Findings from the critical review of the studies can be summarized as follows. Empirical evidence from econometric studies generally supports the simultaneous relationship between changes in wages and prices. The question regarding the most appropriate proxy variable for the demand pressure in the labor market remains unsettled, because various measures of demand pressure are deficient from the conceptual point of view, although the ratio of job openings to job applicants appears to be the most suitable among available measures. The argument of ability to pay is found to be relevant in explaining wage increases, but it is not clear what is the best proxy variable to represent the industry’s ability to pay. A Wage-price determination model that incorporates the dual-structure relationship in the Japanese economy is very useful. A model without this relationship would be severely limited in its use.

Implications drawn from the review for policy measures to curb inflation demonstrate that an incomes policy consisting of wage controls and exchange rate measures would be rather difficult to implement; on the other hand, demand management policies do not appear to be so difficult to implement and seem superior to the incomes policy from an economic point of view.

A Study of the Elasticity of the West Malaysian Income Tax System, 1961–70 1

Nurun N. Choudhry

This study provides an empirical analysis of the built-in elasticity of the income tax system of West Malaysia. In 1967, the enactment of a new income tax ordinance considerably modified the personal income tax structure and imposed an additional minor development tax on company income. To compare the post-1967 income tax structure with that of the earlier structure, the elasticities are estimated by a constant rate base method with respect to two reference years—1961 and 1969. The constant rate base method was applied to assessed income because the degree of disaggregation was available only for assessments. Elasticities of actual collection series were estimated by the proportional adjustment method.

The main results of the study are: (1) The elasticities of the overall income tax system and personal income taxes under the 1969 tax structure exceeded unity but were somewhat lower than the corresponding 1961 tax structure elasticities. The company income tax elasticities under the two structures were the same and almost at unity. (2) The buoyancy and elasticity of actual personal income tax collection are lower than the corresponding estimates for personal income tax assessments, while the opposite is found to be the case for actual company income tax collections and assessments.

An analysis of the elasticities in the context of changes in the effective tax rates and income distribution suggests that the income tax ordinance of 1967 did not materially alter the elasticity of the overall income tax system. A comparison of the magnitudes of the elasticities of actual collections with those of assessed taxes suggests that the administration of company tax was improving over time.

Currency Arrangements and Banking Legislation in the Arabian Peninsula 1

Michael E. Edo

The paper examines the rapid developments in currency arrangements and banking organization that have occurred in the Arabian Peninsula in recent years and analyzes the provisions of relevant financial legislation that has recently been enacted.

Only two decades ago, the Peninsula was predominantly on a metallic standard, with two silver coins (the Maria Theresa thaler and the Indian rupee coin) and the British gold sovereign in widest circulation. As the level of economic activity in the Peninsula increased, full-bodied metallic coins became increasingly unsuitable for use and the Peninsula states first used paper currencies issued elsewhere (the Indian rupee in the Gulf States and the East African shilling in Aden) and then issued their own national currencies.

Institutional development, as discussed in the paper, consisted first of currency boards to issue the currencies and later of central banks or equivalent institutions to manage the currency, supervise credit, and regulate the commercial banking sector. This institutional change occurred against a background of large increases in the foreign exchange surpluses of the oil exporting countries in the Peninsula and of a significant expansion in the number and total assets of the commercial banks.

The establishment of the Saudi Arabian Monetary Agency in 1952 is also described, as well as the institution’s stabilization, banking, and currency management policies in the 1950s and 1960s. In addition, the paper contains an extended discussion of the provisions of the central banking legislation of the various countries as related to purposes, ownership and capital, Boards of Directors, currency and external reserve requirements, and the relations of the central banks to the governments and to the financial institutions.

Inflation Adjustment Schemes Under the Personal Income Tax 2

Amalio Humberto Petrei

A progressive personal income tax combined with inflation can produce significant changes in the distribution of the tax burden among individuals. As money income rises, taxpayers are moved upward in the tax schedule and are thus subject to higher tax rates. Exemptions and deductions defined in nominal fixed amounts may lose their importance, and persons who were not taxed previously because their incomes were below the limits fixed by law may become liable to taxation as a result of inflation.

The most common method of coping with these problems has been to adjust, from time to time, the principal items legally defined in money terms. A few countries have introduced legal provisions to ensure some automatic adjustment of these items in response to price changes. In addition, there have been academic discussions of automatic adjustment schemes and proposals for their implemention.

The paper examines existing and proposed inflation adjustment schemes, compares the technical aspects of these schemes, and discusses the advantages and disadvantages of their adoption.

The main arguments for the adoption of an adjustment scheme rest on equity considerations. Once a desirable distribution of the tax burden has been achieved, changes not deliberately sought can be avoided by introducing a system of automatic adjustment. Although the introduction of an automatic adjustment may sometimes impair the stabilizing power of the tax system, its use can be combined with other measures to preserve the income tax as a useful stabilization tool. In some cases the stabilizing effect of the income tax may even be improved by its introduction. In regard to efficiency, not much can be said with any confidence, although it seems that the adjustment scheme may work in favor of increased risk-taking. The adoption of an adjustment scheme will deprive governments of a convenient method of increasing tax revenues; to replace the proceeds that otherwise would be collected, an effort in tax planning and implementation will be required.



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Mr. Hewson was an economist in the North American Division of the Fund’s Western Hemisphere Department when this note was prepared. He is a graduate of the University of Sydney and the University of Saskatchewan, and he received his doctorate from the Johns Hopkins University. He is presently Visiting Economist, Reserve Bank of Australia.

Mr. Sakakibara, economist in the Exchange Rate Practices Division of the Exchange and Trade Relations Department, is a graduate of the University of Tokyo and received his doctorate from the University of Michigan. He is presently on leave of absence from the Japanese Ministry of Finance.

It should be noted that the deposits and loan functions estimated in the July 1974 paper related only to U.K. banks, while the U.S. balance of payments estimates involve all Euro-currency banks. For weighting purposes a figure of 0.4 was used for the relative size of the U.K. banks to all Euro-currency banks.

The equation for total short-term capital (STK) was estimated from the quarterly data as follows:

where IET, CAP1, and CAP2 are dummies representing U.S. capital controls, SP is a dummy for speculation, and WUS and CL represent variables for U.S. wealth and commercial loans. For a detailed definition of these variables, the reader is referred to John Hewson and Eisuke Sakakibara, “The Impact of U.S. Controls on Capital Outflows on the U.S. Balance of Payments: An Exploratory Study,” in Staff Papers, Vol. 22 (March 1975), pp. 37–60. Assuming that the basic balance of the United States is interest insensitive and noting that the equation for STK was estimated on quarterly data while the multiplier calculations were based on monthly data, 63613=2120.3 is the value for BUSrED for all Euro-currency banks. Using the scaling factor of 0.4 mentioned above, BUSrED for U.K. banks would be 848.12.

It should be noted that the interest elasticities of the deposit and loan function for the Rest of the World were assumed to be equal to the averages of those for the United States and Canada and Western Europe. That is, it was assumed that


where the subscripts USC, WE, and ROW refer to the United States and Canada, Western Europe, and the Rest of the World, respectively.

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