Levin (1983) has argued that the J-curve's conjunction with imperfect asset substitutability and rational expectations necessarily results in overshooting of the exchange rate in response to a real disturbance. We argue here that Levin has excluded three important considerations from his analysis: (i) the response of income and the interest rate to trade balance variations. (ii) the effect of exchange rate changes on the domestic price level, and (iii) the 'valuation effect’ of exchange rate changes on domestic holdings of the foreign asset. We demonstrate that consideration (i) cannot, and considerations (ii) and (iii) can, produce exchange rate undershooting, and we also explore the effect of various parameter configurations on the overall trajectory of the exchange rate. [431]
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Volume (Year): 3 (1989) Issue (Month): 3 (October) Pages: 85-104 Download reference. The following formats are available: HTML
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