Chapters 13 through 16 developed macroeconomic theory for a closed economy — one that neither trades nor borrows internationally. This chapter opens the economy. Goods, services, and capital now flow across borders, and exchange rates become a central macroeconomic variable. The stakes are high: exchange rate crises have destroyed decades of growth in months, and the architecture of international monetary cooperation shapes the policy space of every country on Earth.
We begin with the accounting framework (the balance of payments), move to exchange rate determination (PPP, UIP, Dornbusch overshooting), build a workhorse two-country model (Obstfeld-Rogoff Redux), and then tackle the great policy questions: When should countries share a currency? How should they coordinate monetary policy? When do sovereigns default on their debts? And why does capital flow “uphill” from poor countries to rich ones?
By the end of this chapter, you will be able to:
Prerequisites: Chapters 8 (Mundell-Fleming basics), 13 (dynamic optimization), 14 (DSGE methods), 15 (Calvo pricing, NK model), 16 (Barro-Gordon, FTPL, intertemporal GBC).
Named literature: Mundell (1961, 1963); Fleming (1962); Dornbusch (1976); Obstfeld & Rogoff (1995, 1996); Eaton & Gersovitz (1981); Lucas (1990); Calvo (1998); Balassa (1964); Samuelson (1964); Frankel & Rose (1998); Reinhart & Rogoff (2009).
Every international transaction is recorded in the balance of payments (BOP) — a double-entry ledger that tracks a country’s economic exchanges with the rest of the world. Before we build models, we must master this accounting framework, because it imposes ironclad constraints on what any open economy can do.
Current account. The sum of the trade balance (exports minus imports of goods and services), net primary income (returns on foreign assets minus payments to foreign liabilities), and net secondary income (transfers). In compact form:
where $X_t$ is exports, $M_t$ is imports, $r$ is the return on net foreign assets, $NFA_{t-1}$ is the net foreign asset position at the end of the previous period, and $NTR_t$ is net secondary income (transfers). The trade balance $X_t - M_t$ captures current flows; the net factor income term $r \cdot NFA_{t-1}$ captures income on the accumulated stock of international assets and liabilities; and $NTR_t$ captures remittances, aid, and other unilateral transfers.
Balance of payments identity. The fundamental accounting identity:
where $KA_t$ is the capital (financial) account balance, defined with sign convention such that capital inflows are positive. This is not a behavioral equation — it is an accounting identity that holds by construction. A current account deficit must be financed by a capital account surplus.
Construct the BOP for a country and verify the identity $CA + KA = 0$.
Consider a small open economy with the following annual data (billions of dollars): Goods exports: 250; Goods imports: 310; Service exports: 80; Service imports: 60; Net primary income: -15; Net secondary income: -5; FDI inflows: 30; Portfolio inflows: 45; Other investment inflows: 25; Change in official reserves: -40 (reserve accumulation).
Step 1: Trade balance in goods: \$150 - 310 = -60$.
Step 2: Trade balance in services: \$10 - 60 = +20$.
Step 3: Current account: $CA = (-60) + 20 + (-15) + (-5) = -60$.
Step 4: Capital (financial) account: $KA = 30 + 45 + 25 + (-40) = +60$.
Step 5: Verify: $CA + KA = -60 + 60 = 0$. ✔ The identity holds.
Interpretation: This country runs a current account deficit of \$60B — it consumes and invests more than it produces. The deficit is financed by net capital inflows of \$60B (FDI, portfolio flows, bank lending), partially offset by reserve accumulation of \$40B.
The exchange rate — the price of one currency in terms of another — is perhaps the most important price in an open economy. This section builds from long-run benchmarks (PPP) through short-run arbitrage (UIP) to the Dornbusch overshooting model, which explains why exchange rates are more volatile than fundamentals.
If a basket of goods costs 100 yuan in China and 15 dollars in the U.S., PPP predicts $E = 100/15 \approx 6.67$ yuan per dollar.
where $e_t = \ln E_t$ is the log nominal exchange rate and $\pi_t, \pi_t^*$ are domestic and foreign inflation rates. Relative PPP performs better than absolute PPP empirically — the correlation between inflation differentials and exchange rate changes is strong over horizons of 5 years or more.
If the domestic interest rate exceeds the foreign rate by 2%, UIP predicts the domestic currency will depreciate by 2%. Empirically, UIP fails spectacularly at short horizons — high-interest-rate currencies tend to appreciate, creating excess returns for carry traders (the “forward premium puzzle”).
The magnitude of the overshoot is $\Delta e_{impact} = \Delta m + \frac{\Delta m}{\delta \cdot \lambda}$, where $\lambda$ is the interest semi-elasticity of money demand and $\delta$ is the speed of price adjustment. Slower price adjustment (small $\delta$) produces larger overshooting. (This formula uses the approximation $|\mu| \approx \delta \cdot \lambda$, where $\mu$ is the stable eigenvalue of the system $\mu^2 + \delta\mu - \delta/\lambda = 0$. The approximation is valid when $\delta$ is small relative to \$1/\lambda$.)
Given a 10% permanent money supply increase, compute the instantaneous exchange rate jump, the long-run exchange rate, and trace the adjustment path.
Initial steady state: $e_0 = p_0 = 0$ (logs normalized). Money supply increases by $\Delta m = 0.10$ (10%). Parameters: $\delta = 0.3$, $\lambda = 2$.
Step 1: Long-run exchange rate: $e_{LR} = e_0 + \Delta m = 0.10$. Prices also rise: $p_{LR} = 0.10$.
Step 2: Impact exchange rate: $\Delta e_{impact} = 0.10 + \frac{0.10}{0.3 \times 2} = 0.10 + 0.167 = 0.267$. The exchange rate jumps to 0.267 — a 26.7% depreciation, far exceeding the long-run 10%.
Step 3: After the initial jump, the exchange rate appreciates gradually from 0.267 toward 0.10, while prices rise from 0 toward 0.10.
Step 4: On impact, the interest rate falls. Over time, rising prices reduce real balances, pushing the interest rate back to the world level.
Key insight: The exchange rate overshoots because it bears the entire burden of short-run adjustment when prices cannot move.
Figure 17.1. Dornbusch overshooting phase diagram. The $\dot{p}=0$ and $\dot{e}=0$ loci intersect at the steady state. A money supply increase shifts both loci; the exchange rate jumps to the saddle path and converges gradually. Drag the slider to change the shock size.
Peter Schiff told Joe Rogan's audience that Bitcoin has no intrinsic value — it's a speculative mania that will end like every bubble before it. Michael Saylor fired back: "Bitcoin is the apex property of the human race." The clash crystallizes the "what is money?" debate that monetary theory has wrestled with for centuries. After learning Dornbusch overshooting — where exchange rate volatility emerges from sticky prices meeting instant asset-market clearing — you can see why Bitcoin's price swings are not a temporary bug but a structural feature of an asset with fixed supply and speculative demand.
IntermediateThe Dornbusch model is insightful but ad hoc — it lacks microfoundations. Obstfeld and Rogoff (1995) built the Redux model, a two-country New Keynesian framework with monopolistic competition, nominal rigidities, and explicit welfare analysis.
When the Home currency depreciates, Home goods become cheaper relative to Foreign goods ($\hat{\tau}$ rises), and demand shifts toward Home goods. The elasticity of substitution $\theta$ governs the strength of this switching.
Two symmetric countries; Home monetary expansion. Compute the terms-of-trade change, relative consumption shift, and welfare effect.
Symmetric countries ($\gamma = 0.75$), elasticity $\theta = 2$, Home monetary expansion $\Delta m_H = 5\%$, Foreign unchanged.
Step 1: Terms-of-trade change: $\hat{\tau} = \frac{0.05}{1 + (0.5)(1)} = 0.033$ (3.3% deterioration for Home).
Step 2: Expenditure switching: $\hat{C}_H - \hat{C}_F = 2 \times 0.033 = 0.067$ (6.7% relative demand shift).
Step 3: Home output rises ~6.7%. Home welfare gain ~4.2% (output gain minus terms-of-trade loss).
Step 4: Foreign output falls ~1.7%, but Foreign enjoys a terms-of-trade improvement. Net Foreign welfare is ambiguous.
Key insight: The Redux model shows monetary policy in open economies involves a tradeoff between output stimulus and terms-of-trade deterioration. High openness (low $\gamma$) makes the beggar-thyself effect more likely.
Figure 17.2. PPP vs actual exchange rates. Countries above the 45-degree line have undervalued currencies; below, overvalued. The Balassa-Samuelson pattern is visible: low-income countries systematically above the line. Toggle between decades.
Figure 17.3. Two-country Redux model. Home and foreign monetary shocks interact through expenditure switching. Symmetric shocks cancel; asymmetric shocks create winners and losers. Home bias modulates spillover magnitude. Drag sliders to explore.
When should countries abandon their own currencies in favor of a shared one? Robert Mundell’s (1961) theory of optimal currency areas (OCA) provides the analytical framework.
The formal tradeoff: Benefits $B = \phi \cdot \tau$ (trade share times transaction cost savings). Costs $C = \alpha \cdot \sigma^2_{asymmetric} / \mu$ (shock asymmetry divided by alternative adjustment mechanisms). A monetary union is optimal when $B > C$.
Frankel and Rose (1998) argued that OCA criteria are endogenous: joining a monetary union increases bilateral trade and may synchronize business cycles. Countries that do not satisfy criteria ex ante may satisfy them ex post.
Evaluate whether a hypothetical country pair satisfies Mundell’s criteria.
Consider Alphaland and Betaland. Scores (0–10): Labor mobility: 3 (different languages, restrictive policies). Fiscal transfers: 2 (no supranational authority). Trade openness: 8 (35% bilateral trade). Shock symmetry: 5 (diversified but different structures). Financial integration: 7 (cross-listed banks, free capital flows). Assessment: High trade and financial integration favor union, but low labor mobility and absent fiscal transfers mean asymmetric shocks cannot be easily absorbed — similar to the Eurozone periphery.
Figure 17.4. OCA criteria radar chart. Higher scores on all axes = stronger case for monetary union. The threshold ring (score 6) represents minimum viable OCA. US States dominate; Eurozone Periphery shows clear weakness on shock symmetry and fiscal transfers. Select regions to compare.
You now have the international dimension. The impossible trinity, OCA theory, and Dornbusch overshooting all constrain what central banks can do once the economy is open. This is the final stop.
Dornbusch overshooting shows that monetary policy affects the exchange rate, which overshoots its long-run level — creating volatility that the central bank did not intend. For small open economies, monetary policy works partly through exchange rate depreciation, which is a beggar-thy-neighbor effect that shifts demand from foreign to domestic goods. The impossible trinity constrains the policy space: a country cannot simultaneously maintain free capital flows, a fixed exchange rate, and independent monetary policy. OCA theory reveals that the Eurozone fails on most Mundell criteria — labor mobility, fiscal transfers, synchronized cycles — meaning the ECB's one-size-fits-all rate is too tight for some members and too loose for others.
The ECB's one-size-fits-all policy was too tight for Greece and too loose for Germany during the sovereign debt crisis. A single central bank for diverse economies cannot control all of them effectively — this is central bank loss of control through institutional design. More broadly, for small open economies with open capital accounts, the exchange rate regime determines the scope of monetary policy. Under a fixed exchange rate with free capital flows, domestic monetary policy is entirely subordinated to the peg — the central bank becomes a currency board, not a macroeconomic manager. Even under floating rates, the "fear of floating" literature (Calvo and Reinhart, 2002) shows that most central banks in practice intervene heavily, constrained by original sin, balance sheet effects, and pass-through to inflation.
The ECB evolved through crisis — OMT ("whatever it takes"), PEPP, and expanded asset purchases broadened its toolkit. The IMF moved toward accepting capital flow management measures as legitimate policy tools. But the fundamental tension remains: one rate for twenty economies cannot be optimal for all of them. The post-2020 debate about global inflation demonstrated that even the Fed operates in an international context — dollar tightening transmitted contractionary impulses to emerging markets through capital outflows and currency depreciation.
Across five stops — IS-LM (Ch 8), expectations and Mundell-Fleming (Ch 9), the NK framework and ZLB (Ch 15), time inconsistency and FTPL (Ch 16), and now the international dimension — the answer has progressively narrowed. Central banks can control the economy, but only under increasingly restrictive conditions: (a) independence from fiscal pressure, (b) not being at the ZLB, (c) understanding the transmission mechanism, (d) the fiscal authority not undermining them, and now (e) the exchange rate regime permitting independent policy. The most honest answer: "usually, approximately, under favorable conditions" — and those conditions are more demanding than the profession acknowledged before 2008. For small open economies, the answer is often "barely." For currency unions, the answer depends on which member you ask.
The rise of digital currencies, CBDCs, and capital flow volatility is creating new challenges for central bank control. If stablecoins denominated in dollars circulate globally, does the Fed become the world's central bank by default? If CBDCs enable instant cross-border payments, does the impossible trinity bind even tighter — or does it loosen? These questions connect to BQ10 (what is money?) and remain at the frontier of international monetary economics.
The Eurozone fails most OCA criteria. The sovereign debt crisis confirmed the costs. But the political project endures — and the counterfactual is unknowable.
AdvancedBitcoin promised money without the state. CBDCs promise the state's money without banks. Neither has replaced central banking — but both are reshaping the monetary landscape.
AdvancedWhen one country’s monetary policy spills over to others through the exchange rate, uncoordinated policy becomes a strategic game. Each country faces an incentive to expand, but when all expand simultaneously, exchange rate effects cancel and only inflation remains.
Sustaining cooperation requires institutions: the IMF, the G7/G20, the Plaza and Louvre Accords, and central bank swap lines. In a repeated game, cooperation can be sustained by trigger strategies.
Set up a 2×2 monetary policy game, compute payoffs, identify the Nash equilibrium, and show the cooperative improvement.
Two symmetric countries choose Expand (E) or Tighten (T). Payoffs (loss values, lower is better): (E,E)=(3,3), (E,T)=(1,5), (T,E)=(5,1), (T,T)=(2,2). Expand is a dominant strategy for both. Nash: (E,E) with loss 3. Cooperative: (T,T) with loss 2. Surplus = 1 per country.
Key insight: International monetary policy is a prisoner’s dilemma. Each country rationally pursues competitive depreciation, but the collective outcome is worse than coordinated restraint.
Figure 17.7. Policy coordination game. The 2×2 payoff matrix shows each country’s loss from Expand vs Tighten. Nash equilibrium (red) is Pareto-inferior to the cooperative outcome (green). Higher spillovers widen the gap. Drag the spillover slider.
Sovereign debt differs fundamentally from private debt: there is no international bankruptcy court. Sovereign repayment is ultimately voluntary — a country repays because the costs of default exceed the costs of repayment.
Given initial debt/GDP = 90%, primary surplus = 1%, growth = 2%, interest rate = 4%, compute the debt trajectory and stabilizing surplus.
Step 1: Interest-growth differential: $r - g = 4\% - 2\% = 2\%$.
Step 2: Stabilizing surplus: $s^* = (r - g) \cdot d_0 = 0.02 \times 0.90 = 1.8\%$ of GDP.
Step 3: Actual surplus (1%) is below $s^*$ (1.8%). Debt will rise over time.
Step 4: Trajectory: Year 1: 90.8%, Year 5: 94.2%, Year 10: 98.8%, Year 20: 109.4%, Year 30: 122.5%.
Step 5: To stabilize at 90%, need $s^* = 1.8\%$. To reduce to 60% over 20 years: ~$s = 3.0\%$.
Key insight: If creditors demand higher rates (risk premium feedback), the stabilizing surplus jumps — creating a “debt trap” dynamic.
Figure 17.5. Sovereign debt sustainability. The trajectory depends on the interest-growth differential ($r - g$) and the primary surplus. When $r > g$ and the surplus is insufficient, debt explodes. When $r < g$, debt stabilizes even with small deficits. Drag sliders to explore.
Standard theory predicts that capital should flow from rich countries (abundant capital, low marginal product) to poor countries (scarce capital, high returns). The data tell a different story.
Lucas calculated that if $Y = AK^\alpha L^{1-\alpha}$, the ratio of marginal products between India and the US should be ~58:1. Yet capital was not flooding into India.
The post-2008 consensus has shifted toward accepting some role for capital flow management measures (CFMs). The IMF’s Institutional View (2012, revised 2022) acknowledges that CFMs can be appropriate as a temporary measure when capital inflows are surging.
Figure 17.6. Sudden stop simulator. A capital flow reversal forces instant current account adjustment. The exchange rate regime determines whether the pain falls on the exchange rate (flexible) or on output (fixed). Adjust the reversal magnitude and regime.
Kaelani faces its most severe crisis yet. After the commodity shock (Ch 14) and the ZLB episode (Ch 15), foreign investors abruptly withdraw capital. Portfolio flows reverse from +6% of GDP to -4% in one quarter — a classic sudden stop.
The BOP crisis. Kaelani’s current account deficit of 8% of GDP is suddenly unfinanceable. The BOP identity forces instant adjustment: the current account must swing by 10 percentage points. Exports cannot increase overnight, so adjustment falls on imports.
Exchange rate response. Under Kaelani’s managed float, the currency depreciates 25%. This triggers expenditure switching but also worsens debt: 40% of sovereign debt is dollar-denominated (original sin). Effective debt/GDP jumps from 85% to 95%.
Debt sustainability. With $d = 95\%$, $r = 6\%$, $g = 1\%$: $s^* = (0.06 - 0.01) \times 0.95 = 4.75\%$ of GDP. Current surplus: only 1%. The gap is enormous.
Resolution. Kaelani accepts a modified IMF program: moderate fiscal consolidation ($s = 3\%$), debt reprofile (maturity extension, not haircut), and temporary capital flow management. The crisis stabilizes but leaves scars: output 5% below trend, debt takes a decade to return to pre-crisis levels.
The Kaelani crisis demonstrates every concept: BOP accounting, expenditure switching, original sin, debt sustainability dynamics, sovereign default risk, and the limitations of international policy coordination for small economies.
Asian Financial Crisis (1997–98) and European Sovereign Debt Crisis (2010–12): two crises bracketing the open-economy policy spectrum.
Asia: Thailand’s baht peg collapsed in July 1997. Capital inflows of +10% of GDP reversed to outflows of -10% in months. The crisis exposed the impossible trinity: Thailand tried to maintain a fixed exchange rate, open capital account, and independent monetary policy simultaneously. IMF programs prescribed austerity and high rates — controversial for a capital account crisis. Malaysia imposed capital controls and recovered at a similar pace, challenging Washington Consensus orthodoxy. Original sin amplified the crisis as 40–80% currency depreciations exploded dollar-denominated corporate debt.
Europe: Greece, Ireland, Portugal, Spain, and Italy faced sovereign debt crises within a monetary union. Without their own currencies, they could not depreciate to restore competitiveness — the OCA criteria failure in action. Greece’s debt sustainability arithmetic was stark: $s^* = (0.07 - (-0.04)) \times 1.30 = 14.3\%$ of GDP — impossibly large. The ECB’s “whatever it takes” (Draghi, 2012) eliminated the multiple-equilibrium problem, but the underlying structural issue — monetary union without fiscal union — remains.
You now see that trade is inseparable from capital flows and exchange rates. A trade deficit is a capital account surplus — the "global imbalances" debate can't be understood through trade alone.
BOP accounting forces a fundamental insight: $CA + KA = 0$. A trade deficit means capital inflow — foreigners are investing in your country. The US trade deficit with China reflects, in part, Chinese savings flowing into US assets. Exchange rate movements can mitigate trade imbalances — a depreciating currency makes exports cheaper through expenditure switching. The impossible trinity constrains policy responses: a country cannot simultaneously fix its exchange rate, allow free capital flows, and run independent trade-balancing monetary policy.
Currency manipulation complicates the free trade story. China's managed exchange rate kept the yuan undervalued for decades, providing an unfair trade advantage — this isn't free trade, it's subsidized trade via exchange rate policy. Dutch disease shows that large capital inflows can appreciate the currency and destroy export competitiveness in non-resource sectors, concentrating the economy in a narrow base. The "global savings glut" thesis (Bernanke, 2005) suggests that persistent US deficits were driven not by US profligacy but by excessive savings abroad — meaning the trade imbalance reflected macro distortions, not comparative advantage at work.
The IMF has moved toward surveillance of "external imbalances" and currency manipulation. The mainstream now recognizes that persistent large imbalances can be destabilizing, even if they're consistent with each country's optimal savings-investment behavior. The 2008 crisis was partly a story of global imbalances: Asian savings flowed into US mortgage-backed securities, fueling a credit boom whose collapse nearly destroyed the global financial system. The trade story and the capital flow story are the same story told from different sides of the BOP identity.
Trade deficits are neither inherently good nor bad — they reflect intertemporal trade (borrowing from abroad to invest at home can be optimal). But persistent, large imbalances can create vulnerabilities: the 2008 crisis, the European sovereign debt crisis, and multiple emerging market sudden stops were all partly stories of unsustainable external positions. The exchange rate dimension means trade policy cannot be analyzed in the partial-equilibrium supply-and-demand framework of Chapter 2. Whether trade is "good" depends not just on comparative advantage but on capital flows, exchange rate regimes, and the institutional capacity to manage the adjustment costs.
The Stolper-Samuelson losers still haven't been compensated. The political backlash against trade — Brexit, Trump tariffs, de-globalization — is a response to real economic losses that the profession understated for decades. Come back at Chapter 20 (§20.8) for the development perspective: East Asia's success involved strategic trade policy, not pure free trade. The question of whether industrial policy can work — and under what institutional conditions — is the next frontier.
The China shock literature quantified persistent, concentrated losses. But the BOP identity says the trade deficit is a capital account surplus — maybe America was importing savings, not exporting jobs.
IntermediateTariffs raise revenue, protect some industries, and invite retaliation. In a world of global value chains, taxing imports means taxing your own exports.
IntermediateMoney's nature is further complicated by the international dimension. Exchange rates are prices of moneys — and the dollar's special status as reserve currency gives the US an "exorbitant privilege." The question becomes: why is the dollar the world's money? This is the final stop.
PPP says that in the long run, exchange rates adjust so identical goods cost the same across currencies. UIP says interest rate differentials reflect expected exchange rate changes. In theory, all moneys are fungible up to an exchange rate. The dollar's reserve currency status means global demand for dollars exceeds what purchasing-power considerations would imply — the US can borrow cheaply, run persistent trade deficits, and extract seigniorage from the global system. The NIIP data tell the story: the US has accumulated over \$18 trillion in net international liabilities, yet continues to earn more on its foreign assets than it pays on its foreign liabilities — the "exorbitant privilege" is real and measurable.
The dollar's reserve status isn't a natural market outcome — it was constructed through Bretton Woods, maintained by military power and network effects, and sustained by the lack of credible alternatives. De-dollarization efforts (BRICS, yuan internationalization, CBDCs) are attempts to rebalance this power. Bitcoin and stablecoins propose an even more radical alternative: money without a state. If money is a convention, a decentralized convention might be more stable than one controlled by self-interested governments. The counterargument is sharp: you can't pay taxes in Bitcoin, and you can't easily price goods in a unit that fluctuates 10% per month. Dollarization and "original sin" show that even sovereign nations cannot always sustain their own currency — they end up pricing debt in dollars because that's where the trust is.
The post-Bretton Woods system (floating rates since 1973) was supposed to be symmetric — each country controls its own money. In practice, it is a dollar system. The GFC and COVID both reinforced dollar dominance through flight-to-safety dynamics. CBDCs represent the next frontier: central bank digital currencies could enable instant cross-border settlement, programmable money, and disintermediation of correspondent banking. China's digital yuan, the ECB's digital euro, and the Fed's cautious exploration all reflect the recognition that the form of money is changing — even if its fundamental nature (a self-reinforcing convention backed by institutional trust) may not be.
Across three stops — IS-LM's treatment of money as a policy quantity (Ch 8), the deep theories of CIA, MIU, and FTPL (Ch 16), and now the international dimension — the answer is that money is deeply political. The dollar's dominance is a geopolitical fact that shapes trade, capital flows, and the global power structure. The theoretical question "what is money?" has a practical answer in international finance: money is whatever the dominant power says it is, sustained by network effects, institutional inertia, and the lack of a credible alternative. The different theories from Chapter 16 each illuminate one face: CIA captures the transaction role, MIU captures the convenience yield, FTPL captures the fiscal backing, and chartalism captures the state's role. No single theory is complete. Money is a self-reinforcing equilibrium of mutual acceptance, maintained by institutions — and when those institutions operate across borders, the equilibrium becomes geopolitical.
Will digital currencies reshape what money is? CBDCs could enable programmable monetary policy, instant cross-border settlement, and the disintermediation of the banking system. Stablecoins could create private money at scale. Bitcoin continues to test whether money needs a state. The technology allows possibilities that existing theory hasn't fully absorbed. Whether this is a monetary revolution or a technological evolution within the existing institutional framework is the defining open question of 21st-century monetary economics.
Peter Schiff says Bitcoin is digital tulips. Michael Saylor calls it the apex property. The Rogan debate crystallizes: which theory of money is right, and what does it predict about Bitcoin?
IntermediateThe dollar has been the world's reserve currency since Bretton Woods. De-dollarization is a slow process with no clear destination — and every crisis reinforces the dollar's centrality.
AdvancedBitcoin promised money without the state. CBDCs promise the state's money without banks. Neither has replaced central banking — but both are reshaping the monetary landscape.
Advanced| Label | Equation | Description |
|---|---|---|
| Eq. 17.1 | $CA_t = X_t - M_t + r \cdot NFA_{t-1} + NTR_t$ | Current account |
| Eq. 17.2 | $CA_t + KA_t = 0$ | BOP identity |
| Eq. 17.3 | $E = P / P^*$ | Absolute PPP |
| Eq. 17.4 | $\Delta e_t = \pi_t - \pi_t^*$ | Relative PPP |
| Eq. 17.5 | $E_t[e_{t+1}] - e_t = i_t - i_t^*$ | Uncovered interest parity |
| Eq. 17.6 | $q_t = e_t + p_t^* - p_t$ | Real exchange rate |
| Eq. 17.7 | $\dot{e} = \theta(\bar{e} - e)$ | Dornbusch exchange rate dynamics |
| Eq. 17.8 | $\dot{p} = \delta(e - p + p^*)$ | Dornbusch price adjustment |
| Eq. 17.9 | $C = [\gamma^{1/\theta} C_H^{(\theta-1)/\theta} + (1-\gamma)^{1/\theta} C_F^{(\theta-1)/\theta}]^{\theta/(\theta-1)}$ | CES consumption aggregator |
| Eq. 17.10 | $\hat{C}_H - \hat{C}_F = \theta \cdot \hat{\tau}$ | Expenditure switching |
| Eq. 17.11 | $L_i = (\pi_i - \bar{\pi})^2 + \alpha(y_i - \bar{y})^2 + \beta(e_i)^2$ | Policy loss function |
| Eq. 17.12 | $L^{Nash} > L^{Coop}$ | Coordination gains |
| Eq. 17.13 | $V^{Repay}(b) \geq V^{Default}$ | Eaton-Gersovitz repayment condition |
| Eq. 17.14 | $\Delta d_t = (r_t - g_t) d_{t-1} - s_t$ | Debt sustainability dynamics |
| Eq. 17.15 | $i_t = i_t^{rf} + \rho(d_t, s_t, g_t)$ | Sovereign risk premium |
| Eq. 17.16 | $f'(k) = r + \delta$ | Neoclassical capital allocation |
Coming in Part VI: theory meets the real world. Institutions, behavior, and development.