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To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.jimonfin.2006.04.005 Byline: Giacomo Barisone (a), Rebecca L. Driver (b), Simon Wren-Lewis (c) Abstract: The Fundamental Equilibrium Exchange Rate (FEER) method of calculating an equilibrium real exchange rate is the most widely used alternative to PPP. This paper presents the first comprehensive historical test of FEER calculations for six major economies, using estimates for the last 20 years. We focus on unit root and cointegration techniques both at the individual country level and jointly using panel based estimation. Specifically, we test whether real exchange rates cointegrate with time series for the FEER. Even at an individual country level, the results provide support for the FEER, particularly in Canada, the UK and Germany. Panel unit root tests suggest that the real exchange rate and FEER cointegrate. Overall the results suggest that the FEER approach represents an improvement over PPP in explaining medium- to long-term trends in the real exchange rates of the major industrialised countries. Author Affiliation: (a) UBS Investment Bank, London, UK (b) Association of British Insurers, UK (c) University of Exeter, Exeter EX4 4RJ, UK

To link to full-text access for this article, visit this link: http://dx.doi.org/10.1016/j.euroecorev.2005.04.003 Byline: Campbell Leith (a), Simon Wren-Lewis (b) Abstract: The debate over the Stability and Growth Pact (SGP) as a part of European Monetary Union, has highlighted the need to assess the extent to which fiscal policies of union members should be constrained as a pre-requisite for price stability within the union. In this paper, we develop a two country open economy model, where each country has overlapping generations of finitely lived consumers who supply labour to imperfectly competitive firms which can only change their prices infrequently. We examine the case where the two countries have formed a monetary union, but where the fiscal authorities remain independent. We show that the fiscal response required to ensure stability of the real debt stock is greater when consumers are not infinitely lived. In principle, this allows for some compensating behaviour between governments, but we show that the scope for compensation is limited. The monetary authority can abandon its active targeting of inflation to stabilise the debt of at most one fiscal authority, and any other combination of policies will either result in price level indeterminacy and/or indefinite transfers of wealth between the two economies. Finally, in a series of simulations we show that fiscal shocks have limited impact on output and inflation provided the fiscal authorities meet the (weak) requirements of fiscal solvency. However, when monetary policy is forced to abandon its active targeting of inflation, then fiscal shocks have a much greater impact on both output and inflation. Author Affiliation: (a) Department of Economics, University of Glasgow, Adam Smith Building, Glasgow G12 8RT, UK (b) University of Exeter, ExeterEX4 4QJ, UK Article History: Received 9 December 2003; Accepted 5 April 2005

A new, more complicated model is developed to explain how price and inflation targeting feedback works. This new model indicates that an economic shock can affect the way the rules operate, and it shows the importance of the method used to define inflation.

A New Keynesian model is used to derive a relationship between current and expected future inflation taking into account future inflationary pressure. This relationship is employed to examine inflationary dynamics resulting from real disturbances to the economy. Positive current inflationary pressure can be associated with either rising or falling inflation- a phenomenon which has received little attention to date. A data-based model of the UK is used to provide further evidence on the nature of the response of inflation to real disturbances and to quantify the importance of inertia in goods and labour markets.

Those who formulate economic policy give insufficient information as to their ultimate objectives and how they intend to acheive them. The UK Conservative government claims to use the Medium Term Financial Strategy (MTFS), but lack a systematic approach. In particular, it appears that output is no longer a goal of macroeconomic policy, fiscal policy is no longer used to regulate the economy in the short term and the role of gross domestic product in policy formulation is unexplained.