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Money Illusion and Exchange Rate Dynamics in a Small Open Economy

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  • Chung-Fu Lai

Abstract

This paper investigates the role of money illusion on exchange rate dynamics in a small open economy. We find that whether the exchange rate overshoots in response to a monetary shock is not depend on the parameters such as the consumption elasticity of money demand and the degree of openness proposed by Lane (1997), but the phenomenon of money illusion, this is because the degree of correlation between money demand and consumption is lower with the existence of money illusion, hence the exchange rate must present the excessive adjustment in order to re-achieve the new equilibrium position of the money market, exchange rate overshooting takes place.

Suggested Citation

  • Chung-Fu Lai, 2015. "Money Illusion and Exchange Rate Dynamics in a Small Open Economy," Research in World Economy, Research in World Economy, Sciedu Press, vol. 6(1), pages 199-207, March.
    • Handle: RePEc:jfr:rwe111:v:6:y:2015:i:1:p:199-207
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    References listed on IDEAS

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    1. David Genesove & Christopher Mayer, 2001. "Loss Aversion and Seller Behavior: Evidence from the Housing Market," The Quarterly Journal of Economics, Oxford University Press, vol. 116(4), pages 1233-1260.
    2. Monika Piazzesi & Martin Schneider, 2007. "Inflation Illusion, Credit, and Asset Pricing," NBER Working Papers 12957, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Ryu‐ichiro Murota, 2018. "Aggregate demand deficiency, labor unions, and long‐run stagnation," Metroeconomica, Wiley Blackwell, vol. 69(4), pages 868-888, November.

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