Research Database

This paper, originally published in the fall 1979 Quarterly Review, explains why unfettered markets cannot determine a price at which the currency of one country exchanges for that of another. In effect, any price will work—something which is not true in other markets. The paper then argues that the only feasible regimes for these special markets are floating exchange rates with capital controls or fixed exchange rates with monetary and budget policy coordination.

AK growth models predict that permanent changes in government policies affecting investment rates should lead to permanent changes in a country’s GDP growth. Charles Jones (1995) sees no evidence for this prediction in data for 15 OECD countries after World War II: rates of investment, especially for equipment, have risen while GDP growth rates have not. This article provides evidence supporting the AK models’ prediction. Data back to the 19th century show a strong positive relationship between investment rates and growth rates and short-lived deviations from trends. A strong positive relationship also exists between average rates of investment and growth in postwar data for a large cross-section of countries. To account for the short-run deviations in rates that Jones highlights, the model he used is extended to allow policies to affect not only investment/output ratios but also capital/output ratios and labor/leisure decisions.