ABSTRACT
From November 1980 until February 1985 the dollar effective exchange rate appreciated by approximately 50 and 40 per cent in nominal and real terms respectively. In this chapter we use some of the previously discussed theories of exchange rates to explain the dollar’s meteoric appreciation of the early 1980s. W e shall argue that the main factor explaining the dollar’s appreciation in this period was a positive real interest differential. Up to 1981/2 the latter arises due to the relatively tight monetary policy pursued in the U nited States, thereafter its source may be traced to the stance of fiscal policy. Thus the dollar’s appreciation may be thought of in terms of the simple M undell-Fleming model: tight money and loose fiscal policy have the predicted effect on the exchange rate. Indeed in order to explain the dollar’s appreciation we shall use a version of the MF model corrected for some of the inadequacies noted in C hapter 3. Some other explanations of the dollar’s appreciation, which go some way in explaining its behaviour, are also discussed. The topic of policy co-ordination is also briefly noted in a concluding section.
