This paper extends the Mises-Hayek business cycle theory to open economies with fiat currencies. I explore: (1) the problem of domestic versus international monetary policy with fiat currencies in an international setting. (2) How the feedback effects between central banks in the context of an expansionary monetary contributes to extend and transmit a Mises-Hayek business cycle from big economies to small financially integrated economies. I find that a lengthening of the period of production is not the only effect produced on the capital structure, but also a misallocation of capital goods between the production of tradable and non-tradable goods and services and that business cycles can become more severe when there are open economies with fiat currencies.
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See also Oppers (2002).
See also Haberler (1937, p. 68): “A systematic account of the international aspect of the business cycle on the basis of the theory hitherto under consideration [the Mises-Hayek business cycle theory] has never been attempted.”
It is common to find in the literature references to a fix exchange rate, or pegged exchange rates, between banknotes and gold under a gold standard regime. See, for instance, Eichengreen and Temin (2000, p. 187) and Obstfeld and Rogoff (1996, p. 568). This terminology is misleading. Under a classic gold standard regime banks issue IOUs convertible to a commodity money, but they are not money proper. There is no pegging, for instance, between a cheque and its monetary value. Similarly, since all banknotes are convertible to the same commodity money, there is parity between different banknotes, and not exchange rates. To see an exchange rate between these two banknotes is no different than seeing an exchange rate between two cheques issued under the same currency but by different issuers. The exchange ratio between these cheques does not depend on their demand and supply, but on their respective denominations. A gold exchange standard where the conversion rate for each banknote can be changed by the issuer is a substantial different monetary institution.
Adverse clearing is not free of innacuracies or potential shortcomings. If the clearing among central banks is not fluid enough, then the changes in the stock of reserves occur with a lag that may affect the central bank’s reaction.
Morgenstern (1950) offers an analysis of the accuracy problems in the measurement of economic indicators.
Naturally, the larger the economy the less relevant is this problem.
See also Aglietta and Rzepkowski (2004).
Another explanation for the purchasing power parity puzzle is given by Imbs et al. (2005). Given that disaggregated prices may adjust at an hetergoneous rate, the purchasing power parity puzzle can largely be explained by aggregation bias. In other words, the non-neutral effects of a monetary shock do not stop at the nontradable and tradable level. This explanation, however, has found some negative reviews as being miscronstructed or not empirically relevant (Bergin et al. 2010; Chen and Engel 2005; Gadea and Mayoral 2009).
Also see Corsetti et al. (1999) who models competitive devaluations in a center-periophery framework with three countries, one center and two in the periphery.
Dissagregated data for CPI, which may be used to separate nontradable from tradable goods, is avaiable only since 2000 in the BLS website.
http://www.bls.gov/cpi/cpiqa.htm#Question_2 [Access: 18-Jan-2012].
I use the Case-Shiller 20-City Home Price Index quaterly values since March 2001.
An exception to the flow of labor to the tradable sector when elasticity of substitution is equal to one is the case where foreign debts exceed capital stocks. In that case, the share of labor income over gross national product is bigger than one and the first effect dominates the second ones.
Ritchie (2005, p. 158): “Comparado con un ciclo económico de una economía cerrada, una cantidad dada de estímulo monetario en una economía abierta debería producir un episodio de auge y depresión menos severo. En el modelo anterior, todo el dinero recientemente creado se dirigiría tanto al consumo como a la inversión interna. En un contexto internacional alguno de estos dólares se dirigen a proyectos de inversión en otros países. […] Un modelo de economía abierta, por lo tanto, resulta en un ciclo económico interno más suave, pero también puede disparar fluctuaciones macroeconómicas en otros países.”
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I appreciate comments from Andreas Hoffmann, GP Manish, Ryan Murphy, Malavika Nair and Benjamin W. Powell, Andrew T. Young, and an anonymous referee. The usual caveats apply.
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Cachanosky, N. The Mises-Hayek business cycle theory, fiat currencies and open economies. Rev Austrian Econ 27, 281–299 (2014). https://doi.org/10.1007/s11138-012-0188-2
- Austrian business cycle theory
- Fiat currencies
- Exchange rate
- International business cycle