FEERs and the ERM

Balassa, Bela (1964), 'The purchasing power parity doctrine: a reappraisal ', Journal of Political Economy, vol.72, no. 6, December.

Barrell, Ray , and Simon Wren-Lewis (1989), 'Fundamental equilibrium exchange rates for the G7', CEPR Discussion Paper no. 323.

Bergsten, C. Fred , ed. (1991 forthcoming), International Adjustment and Finance: Lessons of 1985-1990 ( Washington: Institute for International Economics).

Goldstein, Morris , and Mohsin S. Khan (1985), 'Income and price effects in foreign trade ', in R.W. Jones and P.B. Kenen , eds., Handbook of International Economics, vol. II (Amsterdam : North-Holland).

Houthakker, Hendrik S. , and Stephen P. Magee (1969), 'income and price elasticities in world trade', Review of Economics and Statistics, May.

Johnson, Harry G. (1958), 'Increasing productivity, income-price trends, and the trade balance', Economic Journal, September.

Krugman, Paul (1985), 'Is the strong dollar sustainable?', in The US Dollar: Prospects and Policy Options (Federal Reserve Bank of Kansas City).

Marris, Stephen N. (1985), Deficits and the Dollar (Washington : Institute for International Economics, revised edition 1987).

Walters, Alan (1989), 'A critical view of the EMS', in J. A. Dorn and W. A. Niskanen , eds., Dollars, Deficits, and Trade ( Washington: Cato Institute).

Williamson, John (1983), The Exchange Rate System ( Washington: Institute for International Economics, revised edition 1985).

Wren-Lewis, Simon (1991), 'On the analytical foundations of the fundamental equilibrium exchange rate', mimeo.

Wren-Lewis, Simon , Peter Westaway , Soterios Soteri , and Ray Barrell (1990), 'Choosing the rate: an analysis of the optimum level of entry for sterling into the ERM', National Institute Discussion Paper no. 171.

See Krugman (1985) or Marris (1987) for the type of analysis required.

In an interesting recent paper, Simon Wren-Lewis (1991) points out that this implies that the FEER is not independent of the path taken to achieve equilibrium. Slower adjustment by a deficit country will imply a larger transitional deficit, a larger debt that needs to be serviced, and hence a more competitive FEER.

See their publication The International Economics Analyst.

Thus the PPP exchange rate is £1 = DM 3.14 if £1 will buy the same bundle of goods in Britain as DM 3.14 buys in Germany. (This is the latest Goldman Sachs figure, from the June 1991 issue of The International Economics Analyst, table 1.)

This analysis was undertaken prior to German reunification being factored into the macroeconometric models.

Such interdependence arises if higher real wages, which are possible with a less competitive exchange rate, increase labour supply and thus diminish the NAIRU.