The Basic Monetary Model of the Exchange Rate

Giovanni Piersanti

in The Macroeconomic Theory of Exchange Rate Crises

Published in print April 2012 | ISBN: 9780199653126
Published online September 2012 | e-ISBN: 9780191741210 | DOI:
The Basic Monetary Model of the Exchange Rate

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This chapter discusses the basic monetary model of exchange rate determination used in models of currency attacks. The most important result to emerge from this investigation is that in the absence of any sluggishness, the model shows no transitional dynamics: following any shock to the system the nominal exchange rate jumps instantaneously so as to keep the real money balances and all other variables at their steady-state values. Hence, the economy finds itself continuously in steady-state equilibrium. However, current and expected changes in exogenous variables can alter the time path of the exchange rate, setting off an exogenously driven dynamics into the model. This implies that the exchange rate is an entirely forward-looking variable that it depreciates at the same constant rate of the money growth along the equilibrium path, that the equilibrium dynamics of the model is saddle-path stable, and that the optimal policy is stationary over time.

Keywords: monetary model; flexible exchange rates; equilibrium path; exchange rate dynamics; optimal policy

Chapter.  12227 words.  Illustrated.

Subjects: Macroeconomics and Monetary Economics

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