NBER Working Paper No. 1230 (Also Reprint No. r0582)
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.
Document Object Identifier (DOI): 10.3386/w1230
Published: Obstfeld, Maurice and Alan C. Stockman. "Exchange-Rate Dynamics." Handbook of International Economics, edited by P.B. Kenen and R.W. Jones, pp. 917- 977. Amsterdam: Elsevier Science Publishers B.V., (1985).
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