FIRST ARTICULATED by scholars of the ISalamanca school in sixteenth century Spain,1 purchasing power parity (PPP) is the disarmingly simple empirical proposition that, once converted to a common currency, national price levels should be equal. The basic idea is that if goods market arbitrage enforces broad parity in prices across a sufficient range of individual goods (the law of one price), then there should also be a high correlation in aggregate price levels. While few empirically literate economists take PPP seriously as a short-term proposition, most instinctively believe in some variant of purchasing power parity as an anchor for long-run real exchange rates. Warm, fuzzy feelings about PPP are not, of course, a substitute for hard evidence. There is today an enormous and evergrowing empirical literature on PPP, one that has arrived at a surprising degree of consensus on a couple of basic facts. First, at long last, a number of recent studies have weighed in with fairly persuasive evidence that real exchange rates (nominal exchange rates adjusted for differences in national price levels) tend toward purchasing power parity in the very long run. Consensus estimates suggest, however, that the speed of convergence to PPP is extremely slow; deviations appear to damp out at a rate of roughly 15 percent per year. Second, short-run deviations from PPP are large and volatile. Indeed, the one-month conditional volatility of real exchange rates (the volatility of deviations from PPP) is of the same order of magnitude as the conditional volatility of nominal exchange rates. Price differential volatility is surprisingly large even when one confines attention to relatively homogenous classes of highly traded goods. The purchasing power parity puzzle then is this: How can one reconcile the enormous short-term volatility of real exchange rates with the extremely slow rate at which shocks appear to damp out? Most explanations of short-term exchange rate volatility point to financial factors such as changes in portfolio preferences, short-term asset price bubbles, and monetary shocks (see, for example, Maurice Obstfeld and Rogoff forthcoming). Such shocks can have substantial effects on the real economy in the presence of sticky nominal wages and prices. I See Lawrence H. Officer (1982, ch. 3) for an extensive discussion of the origins of PPP theory; see also Dornbusch (1987).

Society can sometimes make itself better off by appointing a central banker who does not share the social objective function, but instead places "too large" a weight on inflation-rate stabilization relative to employment stabilization. Although having such an agent head the central bank reduces the time-consistent rate of inflation, it suboptimally raises the variance of employment when supply shocks are large. Using an envelope theorem, we show that the ideal agent places a large, but finite, weight on inflation. The analysis also provides a new framework for choosing among alternative intermediate monetary targets.

It appears likely that the number of currencies in the world, having proliferated along with the number of countries over the past 50 years, will decline sharply over the next two decades. The question I plan to pose here is: where, from an economic point of view, should we aim for this process to stop? Should there be a single world currency, as Richard Cooper (1984) boldly envisioned? Should there remain multiple major currencies but with a much stricter arrangement among them for stabilizing exchange rates, as say Ronald McKinnon (1984) or John Williamson (1993) recommended? Building on Maurice Obstfeld and Rogoff (2000b, d), I will argue here that the status quo arrangement among the dollar, yen, and euro (which I take to be benign neglect) is not far from optimal, not only for now but well into the new century. And it would remain a good system even if political obstacles to achieving greater monetary policy coordination (or even a common world currency) could be overcome. Again, this is not a paper on, say, the pros and cons of dollarization for small and medium-sized economies, but rather on arrangements among the core currencies. Any blueprint for the future core of the world currency system involves some crystal-ball gazing. But at the same time, recent research in international macroeconomics offers several important insights that can help inform the discussion.

The past decade has witnessed the growth of a large literature on international cooperation in trade and macroeconomic stabilization policy. Virtually all the models developed to date, however, are based on one of two extreme assumptions concerning governments' ability to commit to international agreements. Either they assume that governments can make constitutionally binding long-term agreements, or else they assume that governments have no ability to make legal commitments whatsoever. In the latter case, international policy cooperation is possible only to the extent that reputational factors will allow.' In this paper, I consider a world in which there is no legal mechanism for enforcing long-term international agreements, but where governments must still incur some small direct costs if they renege. These small costs might arise due to legislative or administrative frictions. I also allow for the possibility that international economic policy agreements can include small sidepayments. For example, in negotiating a bilateral reduction in tariffs, two allies could simultaneously agree to redistribute the burdens of defense expenditures.

In recent years, economists have increasingly debated whether multilateral development banks, such as the World Bank, should switch from making subsidized loans to giving outright grants. It is no small question. The combined loans of the World Bank Group and brethren regional entities such as the Asian and Inter-American Development Banks, approach $300 billion. Their funds constitute a main channel through which rich country governments provide assistance to developing country governments. In Bulow and Rogoff (1990), we first developed the case for a shift to outright grants. We argued that under the status quo, a vastly disproportionate share of aid goes to middle income countries via disguised interest subsidies, rather than to the poorest countries. We also argued that a shift to grants would protect donor banks from sometimes having to play a “bad cop” role when trying to collect net repayments rather than fully rolling over loans. The “Meltzer Commission” (International Financial Institution Advisory Commission, 2000) report on government sponsored international lending institutions famously took a similar view. Supporters of the status quo often argue that development bank loans to middle income countries are in fact highly profitable, and are essential for allowing institutions like the World Bank to subsidize aid to poor countries. We shall argue that the Bank’s profitability is an accounting artifice that greatly underestimates the risks of the Bank’s portfolio. Another argument for loans is that multilateral development banks have a superior enforcement technology that helps international debt markets to function more efficiently. Thus loans allow financially strapped governments, including in middle-income countries, to borrow more than they could otherwise. We will argue that this benefit, too, is an illusion. In those cases when official lending does expand a developing country government’s borrowing capacity, it effectively enables the government to commit the country to repayment levels beyond that supported by domestic political consensus, creating moral hazard for shortsighted rulers. In theory, better credit access to finance, say, public infrastructure projects can be highly beneficial. In practice, however, the increased risk of debt crisis all too often outweighs any gain ordinary citizens might enjoy from the loans. Furthermore, moral hazard on the part of lenders, who may be able to induce rich countries into subsidizing the bailout of troubled middle-income borrowers, may mean that aggregate lending is excessive even if multilaterals merely displace equivalent private debt. We do not argue for eliminating assistance to middle-income countries. On the contrary, we would favor expanding aid in general, albeit in far greater proportion to the world’s poorest countries. Note that in principle, any country with market access could use grant flows to help defray interest rate costs on loans if it so chose, but development banks would never need to assume a “bad cop” role in enforcing debt.

In this paper, we explore the relationship between real exchange rates and real interest rate differentials in the United States, Germany, Japan, and the United Kingdom. Contrary to theories based on the joint hypothesis that domestic prices are sticky and monetary disturbances are predominant, we find little evidence of a stable relationship between real interest rates and real exchange rates. We consider both in-sample and out-of-sample tests. One hypothesis that is consistent with our findings is that real disturbances (such as productivity shocks) may be a major source of exchange rate volatility.

Abstract Can massive online retailers such as Amazon and Alibaba issue digital tokens that potentially compete with bank debit accounts? There is a long history of trading stamps and loyalty points, but new technologies are poised to sharply raise the significance of redeemable assets as a store of value. Here, we develop a simple stylized model of redeemable tokens that can be used to study sales and pricing strategies for issuing tokens, including ICOs. Our central finding is that platforms can potentially earn higher revenues by making tokens non-tradable unless they can generate a sufficiently high outside-platform convenience yield.

This paper uses an infinite-horizon model based on individual maximizing behavior to study whether explosive price-level paths unrelated to monetary growth--speculative hyperinflations--can be equilibrium paths under rational expectations. In a pure fiat money regime, speculative hyperinflations can be excluded only through severe restrictions on individual preferences; but when the government fractionally backs the currency by guaranteeing a minimal real redemption value for money, speculative hyperinflations are impossible, even if agents are not completely certain that they can redeem their money in any given period. The analysis also confirms that implosive price-level paths and divergent paths for capital asset prices are not equilibria under either monetary regime.

The Federal Reserve's mandate has evolved considerably over the organization's hundred-year history. It was changed from an initial focus in 1913 on financial stability, to fiscal financing in World War II and its aftermath, to a strong anti-inflation focus from the late 1970s, and then back to greater emphasis on financial stability since the Great Contraction. Yet, as the Fed's mandate has expanded in recent years, its range of instruments has narrowed, partly based on a misguided belief in the inherent stability of financial markets. We argue for a return to multiple instruments, including a more active role for reserve requirements.

A year ago, we presented a historical analysis comparing the run-up to the 2007 US subprime financial crisis with the antecedents of other banking crises in advanced economies since World War II (Reinhart and Rogoff 2008a ). We showed that standard indicators for the United States, such as asset price inflation, rising lever age, large sustained current account deficits, and a slowing trajectory of economic growth, exhibited virtually all the signs of a country on the verge of a financial crisis—indeed, a severe one. In this paper, we engage in a similar com