Working Paper: NBER ID: w5766
Authors: Charles Engel
Abstract: Economic agents undertake actions to protect themselves from the short-run impact of foreign exchange rate fluctuations: Nominal goods prices are set in consumers' currencies, and firms hedge foreign exchange risk. A model is presented here which shows that these features of the economy can lead to indeterminacy in the nominal exchange rate in the short run. There can be noise in the exchange rate, unrelated to any fundamentals, essentially because the short-run fluctuations do not influence any rational agent's behavior. Empirical implications of this sort of noise are explored.
Keywords: foreign exchange rates; international finance; exchange rate volatility
JEL Codes: F31; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| nominal exchange rate changes (F31) | agents' behavior (L85) |
| pricing to market (D40) | exchange rate volatility (F31) |
| nominal price stickiness (E31) | firms' profitability (L21) |