Money has not played a great role in any of the chapters thus far. In Chapters 4 and 5 we linked nominal spending to the money supply via a cash-in-advance constraint, but the supply of money was given exogenously. In this chapter, at last, we give money an important role as a control variable that influences economic activity. We then use the model to address the issue of whether fixed exchange rates are desirable. For a survey of the literature on macroeconomic performance under alternative exchange rate regimes, see Alogoskoufis (1994). Canzoneri and Rogers (1990) discuss the costs and benefits of the European Union (EU) in particular.

We briefly review the different ways of modeling supply and demand for money and the issues associated with exchange rate regimes in Section 9.1. In the remainder of the chapter, we formally analyze the issue of the desirability of fixed exchange rates in a model that contains money as well as a government and still has maximal resemblance to the models discussed in the preceding chapters. Section 9.2 describes the assumptions of this model, and the basic implications of the model are derived in Section 9.3. Section 9.4 examines the conditions under which the exchange rate will be constant over time, given optimal monetary policies.

Money and Exchange Rate Regimes: A Review

In this introductory section we first discuss alternative ways of modeling money demand.