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Among the most sifnificant international developments of the last decade has been the emergence of an exchange rate system characterized by the widespread floating of major currencies. At times during the 1970's, the dollar and other currencies have fluctuated widely in value with respect to one another. The desire to understand better the implications of these exchange rate movements for trade flows, international capital movements, inflation rates, and other important economic variables has generated a substantial research effort. The paper provides a survey of recent contributions to this effort by Federal Reserve System economists, mainly work done in 1979.

In this paper we describe the games that may be played by policy markers in two structurally identical countries following a common external shock such as the oil price increase of 1973. The analysis has two objectives. The first is to investigate the nature of the inefficiencies associated with the non-copperative Nash solutions to these games. in our framework, whether the Nash soluion is too expansionary or too contractionary depands on structural features of the world economy. These structural features have changed over the post-war period and with them, it is argued, the inefficiencies associated with the Nash outcome. Thus, our analysis of the costs of non-cooperative behavior differs from previous work, particularly that of Hamada, which places its emphasis on the preferences of policy makers.

The transversality condition associated with finite horizon maximization problems is well-known. It is sometimes believed that the analogous condition for infinite horizon problems can be obtained simply by replacing evaluations at the terminal time with the limit of these quantities as time tends to infinity. That this belief is incorrect has been shown by Hubert Halkin (1974), who produced an example where an optimal solution to an infinite horizon problem violated the limiting extension of the standard condition.