Working Paper: NBER ID: w1230
Authors: Maurice Obstfeld; Alan C. Stockman
Abstract: This paper discusses the dynamic behavior of exchange rates, focusing both on the exchange rate's response to exogenous shocks and the relation between exchange-rate movements and movements in important endogenous variables such as prices, interest rates, output, and the current account. Aspects of exchange-rate dynamics are studied in a variety of models, some of which are based on postulated supply and demand functions for assets and goods, and some of which are based on explicit individual utility-maximizing problems. Section 1 surveys the terrain. Section 2 explores the simplest model in which the relation among the exchange rate, price levels, and the terms of trade can be addressed -- a flexible-price small-country model in which wealth effects are absent and domestic and foreign goods are imperfect substitutes. Section 3 introduces market frictions so that the role of endogenous output fluctuations can be studied. Both sticky-price models and alternative market-friction models are discussed. Section 4 studies the link between the accumulation of foreign assets and domestic capital and the exchange rate.Section 5 examines deterministic and stochastic models in which individual behavior is derived from an explicit intertemporal optimization problem. Finally, section 6 offers concluding remarks.
Keywords: Exchange Rates; Monetary Policy; Macroeconomics
JEL Codes: F31; F32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| exchange rates (F31) | exogenous disturbances (Q54) |
| exogenous disturbances (Q54) | exchange rates (F31) |
| real shocks (F31) | nominal exchange rate (F31) |
| real shocks (F31) | terms of trade (F14) |
| market frictions (D43) | output fluctuations (E39) |
| output fluctuations (E39) | exchange rate dynamics (F31) |
| foreign assets accumulation (F21) | exchange rate (F31) |
| domestic capital changes (F21) | exchange rate (F31) |
| anticipated future changes in monetary supply (E59) | exchange rate (F31) |