International Finance Theory and Policy
by Steven M. Suranovic

International Finance Theory and Policy Analysis - Course Overview

International Finance is macroeconomics applied to International Economic Issues.

Thus, the course looks at aggregate international economic variables and shows how they are related (or interact with) domestic aggregate variables. The variables of concern in a standard macro class include GNP, unemployment rates, inflation rates, interest rates, money supply, consumption, investment, government spending, taxes, saving, et. al.

The additional aggregate variables of interest in an international finance course include, exchange rates, aggregate exports and imports, trade balances, current account and capital account balances, and the balance of payments.

The main issues the course will cover include,

Exchange Rates - the first section of the course will describe the participants and the workings of the foreign exchange market. The main objective is to develop models that explain how exchange rates are determined in a floating exchange rate system or how private market decisions affect the behavior of the country's central bank in a fixed exchange rate system. There are two main models of exchange rate determination.

1) Interest Rate Parity Model - this model focuses on the actions of international investors and shows how their motivations can influence the supply and demand for currencies in the FOREX (foreign exchange market)

2) Purchasing Power Parity Model - this model focuses on the actions of importers and exporters of goods and services and shows how their motivations can influence supply and demand in the FOREX.

The Balance of Payments - this section will define the record of international transactions that a country makes with the rest of the world, called the balance of payments. International transactions for goods and services are recorded in the current account while international transactions for assets are recorded in a country's capital account. The main issues here are to show the significance of balance of payments, trade current account and capital account deficits and surpluses. We will also show how trade deficits are related to a country's government budget balance.

Open Economy Macroeconomic Policy - this part of the course will involve the development of macroeconomic models in an open economy setting. An open economy simply means one that is open to international trade in goods, services and assets. Here the primary issue is to explain how government fiscal and monetary policy is likely to affect the significant aggregate economic variables like exchange rates and trade balances, but also, GNP growth, interest rates, inflation and unemployment.

International Monetary Systems - as we will see much of the analysis above will depend upon the type of monetary system chosen by a country; most notably whether the country has a fixed or floating exchange rate. Here we will describe many variations of monetary systems that have been used or have been proposed. Perhaps the key issue of this course is to highlight the pros and cons of these monetary system variants. We will examine the Bretton-Woods monetary system, in place after WWII, and the European Monetary system to shed light on these issues.

International Trade Theory and Policy Lecture Notes: Last Updated on 8/20/03