FIXED EXCHANGE RATES, MONETARY POLICY AND MACROECONOMIC

We revisit the issue of independent monetary policies and macroe-conomic interdependence between two economies acting to …x their exchange rate. This paper builds upon the ’new open-economy macroeconomics ’ (NOEM) literature and can be seen as a …xed exchange rate variant of the seminal Obstfeld and Rogo ¤ (1995) exchange rate dynamics paper. The paper constructs a …xed ex-change rate model in the spirit of Mundell’s two country model—see Mundell (1968, Chapter 18)—in which the money supply in each country is endogenously determined under perfect capital mobility following an attempt at a unilateral credit expansion. Unlike the tra-ditional approach however, since the model is derived from intertem-poral optimisation, we are able to analyse the long-run stock impli-cations of the equilibrating reserve ‡ows necessary to bring about the short-run equilibrium. As with its ‡exible exchange rate cousin, the welfare results in this …xed exchange rate model can be surpris-ing, and stand in stark contrast to the implied spillovers in the early ad hoc models