Macroeconomic Policy, Exchange-Rate Dynamics, and Optimal Asset Accumulation
The paper develops a model of exchange-rate and current-account determination for a small economy peopled by infinitely lived, utility-maximizing households. In this setting, a central-bank purchase of foreign exchange has no real effects when central-bank foreign reserves earn interest at the world rate and the proceeds are returned to the public. In contrast, an increase in the monetary growth rate does have real effects, even in the long run. The model developed here implies that an increase in government spending may lead to a surplus on current account. The external adjustment process predicted by the model is one in which consumption, real balances, anti external assets all rise or fall simultaneously.
Obstfeld, Maurice. "Macroeconomic Policy, Exchange-Rate Dynamics, and Optimal Asset Accumulation." Journal of Political Economy, Vol. 89, No. 6, (December 1981), pp. 1142-1161. citation courtesy of