International Finance
Author: Nadezhda Ivanova
e-mail: nsivanova@hse.ru
Course description and objectives
This is an extension of the open economy macroeconomics course for the 3rd and the 4th year
Bachelor students. The course focuses on several topics, with the objective to present both
theoretical models and empirical evidence. It covers the basic model of the current account
determination, fundamentals of the equilibrium real exchange rate, and the classical currency
crises models. The course presents empirical evidence on such key concepts as Purchasing
Power Parity and Uncovered Interest Rate and explanations for the major puzzles in international
macroeconomics suggested in the literature.
The course aims to introduce students to recent debates about the use of open economy
macroeconomic policies with the emphasis on global imbalances, exchange rate regimes and
remedies for natural resource curse. The evolution of exchange rate regimes towards the
currency union in Europe will be discussed in both the historical and theoretical perspectives.
Students will be familiar with the optimum currency area (OCA) theory and learn how well
Eurozone matches to the OCA criteria.
Grading:
25% - home assignment,
75% - final exam
Course outline
1. The intertemporal approach to the current account.
National accounts in open economy. Balance of Payments account. The intertemporal
approach to the current account: the current account and consumption smoothing. The two
period small open economy model: changes in endowment and the current account, adding
government consumption and investment. Empirical evidence on the intertemporal approach
to the current account.
2. Global imbalances
Evolution of global imbalances. Causes of global imbalances: productivity boom and growth
prospects in the USA, low private savings and high budget deficit in the USA, the Global
Saving Glut, East Asian mercantilism, exorbitant privilege, the Federal Reserves’ monetary
policy, financial market imperfections in advances and developing countries.
Global imbalances and the Financial Crisis. Reduction of global imbalances in the post-crisis
period.
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3. The Purchasing Power Parity Puzzle.
The Law of One Price and the Purchasing Power Parity (PPP) in absolute and relative forms:
concepts and conditions to hold. Empirical evidence on the PPP. Simple graphs: short-term
versus long-term phenomenon.
For the 4th year Bachelor students: Formal econometric tests on the PPP: empirical
examination of the real exchange rate’s mean reversion, regression specifications, the null
hypotheses, the power problem, the speed of real exchange rate’s mean reversion. Increasing
the size of the sample: more years, more countries, the problem of “survivorship bias”.
The PPP puzzle. Possible explanations for the PPP puzzle: sticky prices and wages, shocks of
monetary policy, presence of the distribution sector, monopolistic competition, pricing to
market, high transaction costs for consumers, nonlinear dynamics in the real exchange rate
adjustment.
4. The equilibrium real exchange rate
Definition of the real exchange rate (RER) for the small open economy. External and internal
real exchange rates. The RER in the case of the resource-based emerging market economy.
Definition of the equilibrium real exchange rate (ERER). Fundamentals of the ERER. The
ERER and the production possibility frontier. The ERER and the economy’s intertemporal
budget constraint.
De Gregorio and Wolf (1994) model of the small open economy: terms of trade, productivity
differential, government spending, world interest rate as the ERER’s fundamentals.
Empirical estimation of the ERER: Behavioral Equilibrium Exchange Rate and Fundamental
Equilibrium Exchange Rate approaches.
5. The forward premium puzzle
Uncovered Interest Rate Parity (UIP) and Covered Interest Rate (CIP): concepts and
conditions to hold. The forward rate and prediction of the sport rate. The risk premium,
market forecast error, forward forecast error, capital control premium.
Empirical evidence on the UIP, econometric tests for the UIP validity. Forward premium
puzzle for the short term horizons. Support for the UIP at the long term horizons. Volatility
of the risk premium. The carry trade: trading strategy, historical episodes, unwinding of the
carry trade.
Explanations for the forward premium puzzle: the risk premium, noise traders, simultaneity
bias, the “peso problem”, incomplete information with rational learning.
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6. Currency crises: models and empirical regularities.
Empirical regularities of currency crises. The first generation model of crises. Flood and
Garber (1984) linear model with the perfect foresight: inconsistency between the fixed
exchange rate regime and other macroeconomic policies, speculative attack, profit
maximizing investors, the shadow exchange rate, predictability of crises.
The second generation model of crises. Obstfeld (1986) model of self-fulfilling crises:
stochastic shock, investors’ expectations, necessary and sufficient conditions for the crisis,
multiple equilibria. Krugman (1986): rational policy-makers, reason to defend and reasons to
abandon the fixed exchange rate, possibility of self-fulfilling crises in certain range of
fundaments.
The third generation model of crises. Imperfections in financial markets and banking system.
Twin crises – banking and currency crises. Contagion. Asian 1997 and Russian 2008 crises.
7. History of exchange rate regimes, Optimum Currency Area (OCA) Theory.
Eurozone and the OCA.
The Golden Standard: external and internal balance, price-specie-flow mechanism,
advantages and disadvantages of the arrangement, the inter-war period and Great
Depression. The Bretton-Woods System: the US dollar as the reserve currency, asymmetric
arrangement, the IMF. The external imbalance of the USA, the collapse of the BrettonWoods.
The European Monetary System and European Monetary Union: driving forces of European
integration, the Maastricht Treaty, convergence criteria. The choice of the exchange rate
regime. The Theory of Optimum Currency Area (OCA): asymmetric shocks, the criteria of
the OCA. Is Europe the Optimum Currency Area?
8. The Natural Resource Curse: the Dutch Disease and Weak Institutions
The phenomenon of the Resource Curse: historical examples and econometric tests.
Explanations for the Resource Curse: the Prebish-singer hypothesis of a declining trend in
the relative prices of raw materials, volatility of commodity prices, the Dutch Disease, weak
institutions and rent seeking activity.
The symptoms of the Dutch Disease: the real exchange rate appreciation and the deindustrialization. Corden and Neary (1982) model of the Dutch Disease: natural resource
booming sector, manufacturing sector and services, resource movement and sending effects
of the boom, direct and indirect de-industrialization. The Dutch Disease and growth
enhancing characteristics of manufacturing sector. The Dutch Disease and macroeconomic
procyclicality.
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The natural resources, institutions and economic growth: hypotheses and empirical
evidence. Natural resources and political system. Institutions and policies to address the
Resource Curse.
Reading list
Although there is no single book for the course, the main readings refer to the following
textbooks:
Burda. M., and C. Wyplosz “Macroeconomics: A European Text”, 2nd-5th edition, Oxford
University Press., 1997-2012
Krugman P.R.and M. Obstfeld “ International Economics. Theory and Policy” 5-8th edition,
Addison Wesley, 2003-2009
Obstfeld M. and K. Rogoff “Foundations of International Macroeconomics”, The MIT
Press,1996
In addition, class discussions will be based on the selected theoretical, empirical and policy
papers. Students are expected to read materials marked by (*), but encourages to get familiar
with others as well. The reading list may be updated during the course.
1. The intertemporal approach to the current account
*Obstfeld M. and K. Rogoff “Foundations of International Macroeconomics”, The MIT
Press, 1996. Chapter 1
*Krugman P.R.and M. Obstfeld “ International Economics. Theory and Policy” 5-8th
edition, Addison Wesley, 2003-2009. Chapter 12
Further readings:
Obstfeld M. and K. Rogoff (1995) “The Intertemporal approach to the current account” in
G. M.Grossman and K. Rogoff, eds. Handbook of International Economics, Vol.3
Obstfeld M. and K. Rogoff (2000) “The Six Major Puzzles in International
Macroeconomics: Is There a Common Cause?” NBER Macroeconomics Annual, Vol. 15
(2000), pp. 339-390
2. Global imbalances
Xafa M. (2007) “Global Imbalances and Financial Stability”, IMF Working Paper
WP/07/111.
*Obstfeld & Rogoff (2009) “Global Imbalances and the Financial Crisis: Products of
Common Causes”
*Blanchard & Milesi-Ferretti (2009) “Global imbalances: past, present, and future”
*Suominen, K., 2010. Did Global Imbalances Causes the Crisis?.
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*Chinn, Eichengreen, Ito (2011) “A Forensic Analysis of Global Imbalances” (без
эконометрики)
Borio & Disyatat (2011) “Global imbalances and the financial crisis: Link or no link?” BIS
WP 346
3. The PPP Puzzle
* Taylor A. M.and M. P. Taylor (2004) “The Purchasing Power Parity Debate”, Journal of
Economic Perspectives—Volume 18, Number 4—Fall 2004—Pages 135–158
Obstfeld M. and K. Rogoff (2000) “The Six Major Puzzles in International
Macroeconomics: Is There a Common Cause?”, NBER WP 7777
Froot, K., and Rogoff (1995) “Perspectives of PPP and Long-Run Real Exchange Rates”, in
Handbook of International Economics, Vol.3, ed. By G. Grossman and K.Rogoff, p.1647-88
Rogoff K.(1996) “The Purchasing Power Parity Puzzle”, Journal of Economic Literature,
Vol. XXXIV (June 1996), pp.647-668
Sarno, L., Taylor M. The Economics of Exchange Rates, Cambridge University Press, ch. 3.
4. The equilibrium real exchange rate
* Burda. M., and C. Wyplosz (1997) Macroeconomics: A European Text, 2nd edition,
Oxford University Press, Chapter 7.
Clark P.B. and R.MacDonald (1998) “Exchange Rates and Economic Fundamentals: A
Methodological Comparison of BEERs and FEERs”, IMF Working Paper, WP/98/67
* De Gregorio, J., and H.C. Wolf (1994) “Terms of Trade, Productivity, and the Real
Exchange Rate”, NBER Working Paper No.4807.
Obstfeld M. and K. Rogoff “Foundations of International Macroeconomics”, The MIT
Press,1996 (OR-1996), Chapter 4.
5. The forward premium puzzle
*Burda. M., and C. Wyplosz (1997) Macroeconomics: A European Text, 2nd edition, Chapter
19.2-19.3.
Lewis K. (1995) Puzzles in International Financial Markets in G. M.Grossman and K.
Rogoff, eds. Handbook of International Economics, Vol.3
Obstfeld M. and K. Rogoff (1996) “Foundations of International Macroeconomics”, Chapter
8.7.5
*Frankel, J., 2007. Getting Carried Away: How the Carry Trade and Its Potential Unwinding
Can Explain Movements in International Financial Markets.
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Burnside, C., Eichenbaum, M.S. and Rebelo, S., 2008. Do Peso Problems Explain the
Returns to the Carry Trade?, NBER Working Paper 14054.
6. Currency crises: models and empirical regularities
*Flood, R.P, and P.M. Garber (1984) “Collapsing Exchange-Rate Regimes”, Journal of
International Economics 17, p.1-13
Krugman P.R.and M. Obstfeld “ International Economics. Theory and Policy” 5-8th edition,
chapter 17 (Appendix 2)
Obstfeld, M. (1986) “Rational and Self-Fulfilling Balance of Payments Crises”, American
Economic Review 76(1), March 1986, 72-81
* Krugman, P. (1996) “Are Currency Crises Self-Fulfilling?” NBER Macroeconomic Annual
1996, 345-506.
*Pesenti, Paolo and Cédric Tille, “The Economics of Currency Crises and Contagion: An
Introduction”, FRBNY Economic Policy Review 6(3), September 2000, p. 3-16.
http://www.newyorkfed.org/research/epr/00v06n3/0009pese.pdf
Kaminsky G.L., and C.M. Reinhart (1999) “The Twin Crises: The Causes of Banking and
Balance-of-Payments Problems”, The American Economic Review, vol.89, No.3, 473-500.
Krugman, P. (1998) “What Happened to Asia?”,
http://web.mit.edu/krugman/www/DISINTER.html
Chang, R. and A. Velasco (1999) “Liquidity Crises in Emerging Markets: Theory and
Policy”, Federal Reserve Bank of Atlanta, Working Paper 99-15, October 1999, and NBER
Macroeconomics Annual 1999, Volume 14. Ben S. Bernanke and Julio Rotemberg, ed., The
MIT Press, Cambridge, 2000. Section 1-2.
*Roubini, N. (2000) Comment to Chang, R. and A. Velasco “Liquidity Crises in Emerging
Markets: Theory and Policy”, NBER Macroeconomics Annual 1999, Volume 14. Ben S.
Bernanke and Julio Rotemberg, ed., The MIT Press, Cambridge, 2000.
Further readings:
Krugman, P. (1979) “A Model of Balance-of-Payments Crises”, Journal of Money, Credit,
and Banking, 11(3), 311-325.
Kaminsky G.L., and S. Lizondo ,C.M. Reinhart (1998) “Leading Indicators of Currency
Crises”, IMF stuff Papers, Vol.45, No.1, (March 1998), p.1-48
Berg, A., and C. Pattillo (1999) “A Currency Crises Predictable? A Test”, International
Monetary Fund Staff Papers 46(2), June 1999.
Corsetti, G., P. Pesenti, and N. Roubini (1998) “What Caused the Asian Currency and
Financial Crisis?. Part I: A Macroeconomic Overview”, NBER Working Paper 6833.
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Corsetti, G., P. Pesenti, and N. Roubini (1998) “What Caused the Asian Currency and
Financial Crisis?. Part I: The Policy Debate”, NBER Working Paper 6834.
7. History of Exchange rate regimes, the Optimum Currency Area (OCA) Theory. Eurozone
and the OCA.
*Krugman P.R.and M. Obstfeld “ International Economics. Theory and Policy” 5-8th
edition, Chapter 19 (International Monetary Systems: A Historical Overview), Chapter 20
(Optimum Currency Arrears and The European Experience)
*Baldwin R. and C. Wyplosz “The Economics of European Integration” , Chapter 10
(Europe’s exchange rate question), Chapter 11 (Optimum Currency Arrears)
Frankel J. (1999) “No single Currency Regime is right for all countries or at all times”
NBER WP 7338
8. The Natural Resource Curse: the Dutch Disease and Weak Institutions
*Boschini, A.D., Pettersson, J. and Roine J. (2003) “ Recourse curse or not: A question of
appropriability”, The Scandinavian Journal of Economics, Volume 109, Issue 3, pages 593–
617, September 2007.
*Corden M., and J.P. Neary J.P. (1982) “Booming Sector and De-Industrialization in a Small
Open Economy”, Economic Journal, Vol. 92, 825-848.
Frankel J. (2010) “The Natural resource Curse: A Survey” NBER WP 15836
Mehlum, Halvor, Moene, Karl, Torvik, Ragnar (2006) “Institutions and The Resource Curse”.
Economic Journal 116, 1 –20.
*Sachs, J. and A. Warner (1995), “Natural Resource Abundance and Economic Growth”,
NBER Working paper 5398.
Wijnbergen, S. (1984), “The "Dutch Disease": A Disease After All?”, The Economic Journal
94, p. 41-55
Further readings:
Corden M. (1984) “Booming Sector and Dutch Disease Economics: Survey and
Consolidation”, Oxford Economic Papers 36, p- 359-380.
Durnev, A., and S. Guriev(2007) “The Resource Curse: A Corporate Transparency Channel”,
CEFIR Working Paper 108.
Egorov, E., and S. Guriev, K.Sonin (2007) “Media Freedom, Bureaucratic Incentives, and the
Resource Curse”, CEFIR Working Paper 63.
Hutchison, M.M. (1994), “Manufacturing Sector Resiliency to Energy Booms: Empirical
Evidence from Norway, the Netherlands, and the United Kingdom”, Oxford Economic
Papers, New Series, 46 (2), p. 311-329
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Hausman, R., and R. Rigobon (2002) “An Alternative Interpretation of the “Resource Curse”:
Theory and Policy Implications”, NBER Working paper 9424.
Hodler, R. (2006) “The curse of natural resources in fractionalized countries”, European
Economic Review, 50 (2006), 1367-1386.
Leite, C., and J. Weidmann (1999) “Does Mother Nature Corrupt? Natural Reseources,
Corruption and Economic Growth”, IMF Working Paper 99/85.
Mauro, P. (1995) "Corruption and Growth", Quarterly Journal of Economics, 110(3), 681713
Robinson, J.A., Torvik, R., Verdier, T. (2006) “Political foundations of the resource curse”,
Journal of Development Economics
Ross, M.L. (2001) “Does oil hinder democracy?” World Politics 53, 325–361.
Sachs, J. and A. Warner (2001), “The Course of Natural Resources”, European Economic
Review 45, p. 827-838
Sala-i-Martin, X., and Subramanian, A, (2003), “Addressing the Natural Resource Curse: An
Illustration from Nigeria”, IMF Working Paper 03/139.
Tornell, A., and P.R.Lane (1999) “The Voracity Effect” The American Economic Review,
Vol. 89, No. 1, 22-46
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