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Charles Engel
- 28 April 2006
- WORKING PAPER SERIES - No. 614Details
- Abstract
- This paper develops a view of exchange rate policy as a trade-off between the desire to smooth fluctuations in real exchange rates so as to reduce distortions in consumption allocations, and the need to allow flexibility in the nominal exchange rate so as to facilitate terms of trade adjustment. We show that optimal nominal exchange rate volatility will reflect these competing objectives. The key determinants of how much the exchange rate should respond to shocks will depend on the extent and source of price stickiness, as well as the elasticity of substitution between home and foreign goods. Quantitatively, we find the optimal exchange rate volatility should be significantly less than would be inferred based solely on terms of trade considerations. Moreover, we find that the relationship between price stickiness and optimal exchange rate volatility may be non-monotonic.
- JEL Code
- F41 : International Economics→Macroeconomic Aspects of International Trade and Finance→Open Economy Macroeconomics
E52 : Macroeconomics and Monetary Economics→Monetary Policy, Central Banking, and the Supply of Money and Credit→Monetary Policy - Network
- International research forum on monetary policy
- 1 August 2003
- WORKING PAPER SERIES - No. 248Details
- Abstract
- Standard economic models hold that exchange rates are influenced by fundamental variables such as relative money supplies, outputs, inflation rates and interest rates. Nonetheless, it has been well documented that such variables little help predict changes in floating exchange rates -- that is, exchange rates follow a random walk. We show that the data do exhibit a related link suggested by standard models
- JEL Code
- F31 : International Economics→International Finance→Foreign Exchange
F37 : International Economics→International Finance→International Finance Forecasting and Simulation: Models and Applications
G15 : Financial Economics→General Financial Markets→International Financial Markets
G12 : Financial Economics→General Financial Markets→Asset Pricing, Trading Volume, Bond Interest Rates