Professor Gandolfo is positively one of the profession's most gifted authors of graduate and advanced undergraduate textbooks in the areas of mathematical modeling and international economics. His books are remarkable for their clarity of exposition, scope, mathematical rigor, attention to detail, balance, and sense of history. His most recent textbook, International Finance and Open-Economy Macroeconomics, which is a completely revised and updated edition of the second volume of International Economics [Gandolfo (1995)], continues this legacy.

During the past decade, the field of international macroeconomics has undergone a sea change in the kind of research it produces and the models it proffers to its graduate students. At the graduate level, the older approaches of the neoclassical synthesis, such as the Mundell–Fleming (MF) model and the monetary approach to the balance of payments (MABP), have been swept away in favor of what can now be called the modern approach. The modern approach is based on the idea that aggregate outcomes are best understood by studying the behavior of an intertemporally optimizing representative agent (or two), whose lifetime expectation of all future economic variables is based on perfect knowledge of the model written down by the economic analyst. Since money is mostly a contrivance in these models, it is becoming typical of textbooks to use mainly real models of resource allocation.¹

This sea change in the field has occurred despite the continued empirical success of the older approaches. Indeed, when one wants to understand such issues as how monetary and fiscal policy work in an open economy, the collapse of the European monetary system in the early 1990's, the difficulties of Argentina and Brazil a decade later, the latest IMF stabilization plan, or why flexible exchange rates are so volatile, one pulls out of the draw the older approaches, leaving the newer models untouched. In talking about the MF model, Krugman (1993) argued that “we do know how monetary and fiscal policy work in open economies, and we know how they are transmitted internationally under fixed and floating exchange rates.”²

The modern approach, however, has become a large part of the language used by academic macroeconomists. Clearly, the older approaches are dissatisfying on a number of accounts. They are essentially short-run stories that ignore the intertemporal consequences of saving, investment, and current account imbalances. Moreover they are not designed to answer some of the most pressing questions, for example, what did European economies give up by joining a monetary union or what are the implications of the demographic shifts now occurring in developed countries for saving, investment, and current account imbalances? It is important, therefore, for graduate students to master not only the older approaches, but the modern approach as well. International Finance and Open-Economy Macroeconomics not only covers them both, but does so at both the advanced undergraduate and graduate levels.

Professor Gandolfo accomplishes this in two steps. The main chapters of the text (there are 24 in all) provide undergraduate-level treatments of the issues and economic theory using basic algebra and graphs. This is followed by 18 companion appendices that build on the analysis of the main chapters and provide graduate-level coverage using state-of-the-art mathematical techniques (including differential equation systems, stability analysis, and optimal control). The book is really two books in one.

The main chapters are organized into seven sections. Section I, entitled “The Basics,” includes coverage of the institutions and practices of the foreign exchange market, interest rate parity, market efficiency, and balance-of-payments accounting. Most graduate-level textbooks in the field now provide only cursory treatment of this material at best. But how can we expect our graduate students to think creatively about exchange rate movements without a good mental picture of the foreign exchange market, or fully understand open-economy macro modeling, let alone contribute to its development, without mastering balance-of-payments accounting and the real- and financial-flow relationships that result? The attention to detail that Professor Gandolfo brings to the discussion of balance-of-payments accounting makes his treatment of this topic the best out there, hands down.

Sections II and III examine the adjustment mechanisms operating in an open economy. These sections provide the core theory of the older approaches. Section II develops the flow approaches (i.e, the elasticity approach to the balance of payments and the exchange rate, the one- and two-country Keynesian models of income and the MF model), while section III develops the stock and stock-flow approaches (i.e., the MABP and the portfolio-balance approach under both fixed and flexible exchange rates). At each step, Professor Gandolfo emphasizes the policy implications of the various models. (There is an entire chapter on the policy implications of the MF model, along with a marvelous discussion and analysis of the assignment problem.)

Section IV focuses specifically on exchange rate issues, including exchange rate determination, currency crises, and the debate over the choice between fixed and flexible rates. This section develops all of the major approaches to modeling exchange rates in a clear and balanced way. It also reviews the empirical literature on this topic.

Section V develops the modern intertemporal approaches to the current account and the exchange rate, including the NATREX and the redux models. Sections VI and VII examine a number of the major issues in the field, including international monetary integration, European monetary union, key events in the postwar international monetary system, international liquidity, policy coordination, and proposals for managing exchange rates.

Placing the advanced theory in appendices allows Professor Gandolfo to concentrate on painting the big picture in. Professor Gandolfo writes with a sense of history, not only in terms of the events, the main chapters institutions, and issues that have shaped the post-WWII international financial system, but also in terms of the ideas and problems that have shaped the development of international macroeconomic theory. In developing and applying theory, Professor Gandolfo stresses the intuitive arguments with unmatched clarity and detail. His penchant for detail leads him to examine the various approaches from all angles. Few angles are left unexamined.

For example, after developing the MF model under fixed rates, Professor Gandolfo notes, among other things, that the analysis is short term in nature and unlikely to correspond with the point of full equilibrium in the balance of payments. This is partly because the stock of foreign debt will, in general, be changing despite a balance in the balance of payments, leading to changes in interest payments and further shifts in the model. This leads Professor Gandolfo into a discussion of the stock-flow issue, which is one of the major themes in the book. Most textbook treatments of the MF model ignore the stock-flow problem, but inspecting the model from all possible angles encourages students to think deeply about the approach and allows them to uncover its strengths and weaknesses. I know of no other book that pays as much attention to detail.

The decision to place the graduate-level material into self-contained appendices facilitates Professor Gandolfo's penchant for detail. For example, in the appendix to Chapter 2, he works through the general case of N-point arbitrage, after having presented two- and three-point arbitrage in the main chapter. And in the appendix to Chapter 8, he derives the multiplier with foreign repercussions in an N-county model with intermediate goods, after presenting the basic two-country model of income in the main chapter.

The appendices are comprehensive and illuminating, and provide not only mathematical treatments of the topics in the main chapters, but also textbook treatments of seminal articles on major topics. Professor Gandolfo's treatment of the redux model, which he simplifies by assuming two periods, is fantastic and exactly what students need before they venture onward with the original material. On currency crises, Professor Gandolfo works through the mathematics of the first-generation model of Flood and Garber (1984) and the second-generation model of Sachs et al. (1996). The appendices (along with the main chapters) also provide up-to-date references to all of the important papers in the literature. This bibliography, together with the advanced mathematical treatments and graduate-level reviews of seminal papers, make International Finance and Open-Economy Macroeconomics an invaluable resource for both students and scholars.

I have been teaching international macroeconomics for the past 13 years, at all levels and at a number of universities both in the United States and in Europe. My main objective in these classes has been to provide students with the institutional background and theory needed to make sense of the many issues and problems of open-economy macroeconomics. At the graduate level, I also want my students to learn the technical language needed to understand and contribute to the academic debate. I have found earlier editions of International Finance and Open-Economy Macroeconomics to be indispensable in achieving this end. The new edition improves on the old and I recommend it to you very highly.