The paper examines welfare effects and the trade balance response to changes in the world oil prices and interest rates for a small oil-importing economy. The trade balance is mainly seen as the difference between saving and investment, and these are derived from intertemporal optimization. It is shown that the welfare effects consist of static terms-of-trade effects, intertemporal terms-of-trade effects, and employment effects. The trade balance deteriorates for temporary oil price increases; whereas its response is ambiguous for permanent oil price increases. For a fall in the world interest rate, the trade balance deteriorates if the economy is a net borrower.

[This paper emphasizes the importance of endogenous (price) uncertainty as distinct from the standard exogenous uncertainty about the state of the world. Markets where agents can enter into forward contracts contingent upon future spot prices are studied with respect to existence of equilibrium, occurrence of speculation, and efficiency.]

Social Value of Public Information: Comment: Morris and Shin (2002) Is Actually Pro-Transparency, Not Con by Lars E. O. Svensson. Published in volume 96, issue 1, pages 448-452 of American Economic Review, March 2006

This paper is a brief evaluation of the Eurosystem's monetary-policy regime after its first year, in particular of the extent to which it is similar to inflation targeting as practiced by an increasing number of central banks. I examine the Eurosystem's goals, framework for monetary-policy decisions and communication with outsiders. Criteria for evaluation are whether the goals are unambiguous and appropriate; whether the decision framework is efficient in collecting and processing information and reaching decisions that are appropriate relative to the goals; and whether the communication is effective in motivating decisions, simplifying external evaluation and thereby improving transparency and accountability. I also consider whether the actual instrument setting has been appropriate, given the informaion available at the times of decision.

This paper developes a theory of the international trade pattern in risky assets by applying the law of comparative advantage to asset trade. According to this law there is a tendency for a country to import assets that have relatively high autarky prices. The Autarky price of an asset is high if the autarky real interest rate is low, or if the asset's autarky risk measure (the product of the risk premium and the asset price) is low. It is examined how autarky interest rates and risk measures are affected by international differences in (i) stochastic properties of output/endowments, (ii) the rate of time preference, (iii) the degree of risk aversion, and (iv) subjective beliefs, and how such differences predict overall capital account deficits or surpluses as well as the composition of the capital account into trade in arbitrary risky assets and the special cases of sure indexed bonds, stocks (claims to output), and Arrow-Debreu securities.

A time-varying stochastic devaluation risk is introduced in a model of exchange rate target zones. The model produces realistic patterns of covariation between exchange rates and interest rate differentials, which previous target zone models have been unable to do. A “drift adjustment” method to estimate devaluation expectations from data is suggested.

[We present a new solution to the time-consistency problem that appears capable of enforcing ex ante policy in settings where other enforcement mechanisms do not work. The solution involves a social contract that specifies the optimal ex ante policy and is effectively sold by successive old generations to successive young generations, who pay for the social contract through intergenerational transfers. Both old and young generations have an economic incentive to fulfill the social contract.]

A conservative government, in favor of a low level of public consumption, knows that it will be replaced by a government in favor of a larger level of public consumption. We show that the resulting level of public consumption is in between the levels the two governments would choose if each were in power both in the present and in the future. In particular, we show that if the conservative government is more stubborn (in a particular sense) than the succeeding government, the conservative government will borrow more than it would had it remained in power in the future.

Central banks target CPI inflation; independent central banks are concerned about their balance sheet and the level of their capital. The first fact makes it difficult for a central bank to implement the optimal escape from a liquidity trap, because it undermines a commitment to overshoot the inflation target. We show that the second fact provides a solution. Capital concerns provide a mechanism for an independent central bank to commit to inflate ex post. The optimal policy can take the form of a currency depreciation combined with a crawling peg, a policy advocated by Svensson as the “Foolproof Way” to escape from a liquidity trap.