Working Paper: NBER ID: w1173
Authors: Maurice Obstfeld; Kenneth Rogoff
Abstract: This paper studies exchange rate behavior in models with moving long-run equilibria incorporating alternative price-adjustment mechanisms.The paper demonstrates that price-adjustment rules proposed by Mussa andby Barro and Grossman yield models that are empirically indistinguishable from each other. For speeds of goods-market adjustment that are "too fast," the Barro-Grossman rule appears to induce instability; but we argue that when the ruleis interpreted properly, models incorporating it are dynamically stable regardless of the speed at which disequilibriumis eliminated. The Barro-Grossman pricing scheme is shown to be a natural generalization, to a setting of moving long-run equilibria, of less versatile schemes proposed in earlier literature on exchange rate dynamics.
Keywords: Exchange Rates; Price Adjustment; Rational Expectations
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Mussa's price-adjustment rule (F16) | structurally equivalent models of exchange rate behavior (F31) |
| Barro-Grossman's price-adjustment rule (D40) | structurally equivalent models of exchange rate behavior (F31) |
| Barro-Grossman pricing scheme (D49) | anticipated shocks do not cause disequilibrium (D50) |
| Barro-Grossman rule (when interpreted correctly) (H21) | dynamically stable models (C62) |
| price-adjustment rules (Mussa's and Barro-Grossman's) (L11) | similar empirical outcomes (C90) |
| choice between Mussa's and Barro-Grossman's rules (E19) | not critical for theoretical and empirical applications (C20) |