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Rational Expectations, Endogenous Currency Substitution, and Exchange Rate Determination

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  • Harvey E. Lapan
  • Walter Enders

Abstract

The paper employs the intergenerational model to derive the demands for domestic and foreign currencies from microeconomic optimizing behavior. In the absence of government policy, we obtain the Kareken and Wallace result that exchange rates are constant and indeterminate. We discuss the reasons why nations may find it in their interests to impose probabilistic capital controls. It is shown that the imposition of probabilistic capital controls yields a unique (generally nonstationary) exchange rate path and that this path is determined in accord with the Monetary Approach. As the probability of controls tends to zero, the exchange rate remains determinate.

Suggested Citation

  • Harvey E. Lapan & Walter Enders, 1983. "Rational Expectations, Endogenous Currency Substitution, and Exchange Rate Determination," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 98(3), pages 427-439.
    • Handle: RePEc:oup:qjecon:v:98:y:1983:i:3:p:427-439.
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    File URL: http://hdl.handle.net/10.2307/1886019
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    Cited by:

    1. Obstfeld, Maurice & Stockman, Alan C., 1985. "Exchange-rate dynamics," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 18, pages 917-977, Elsevier.
    2. Arifovic, Jasmina, 2001. "Evolutionary dynamics of currency substitution," Journal of Economic Dynamics and Control, Elsevier, vol. 25(3-4), pages 395-417, March.
    3. Alberto Giovannini & Bart Turtelboom, 1992. "Currency Substitution," NBER Working Papers 4232, National Bureau of Economic Research, Inc.

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