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A Behavioral Macroeconomic Model of Exchange Rate Fluctuations with Complex Market Expectations Formation

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  • Peter Flaschel
  • Florian Hartmann

    ()

  • Chris Malikane
  • Christian R. Proaño

Abstract

The paper investigates the emergence of complex market expectations (opinion dynamics) around nominal exchange rate adjustments using a macro-financial model of a small open economy featuring heterogeneous expectation formation (chartists and fundamentalists) and gradual adjustment processes in real and also to a certain degree in financial markets. The model shows among other things the mechanisms through which the first type of agents tends to destabilise the economy. Global stability can be ensured if opinions turn to fundamentalist behaviour far off the steady state. This interaction of expectations and population dynamics is bounding the – due to chartist behavior – potentially explosive real-financial market interactions, but can enforce irregular behavior within these bounds. The size of output and exchange rate fluctuations can be dampened by adding suitable policy measures to the dynamics of the private sector.

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File URL: http://www.iew.uni-osnabrueck.de/repec/iee/wpaper/13909374_WP_98.pdf
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Bibliographic Info

Paper provided by Institute of Empirical Economic Research in its series Working Papers with number 98.

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Length: 26
Date of creation: 29 Jan 2014
Date of revision: 29 Jan 2014
Handle: RePEc:iee:wpaper:wp0098

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Related research

Keywords: Nonlinear Exchange Rate Dynamics; Opinion Dynamics; Viability; Persistent and Irregular Fluctuations; Macroeconomic Policy;

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References

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  1. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2008. "New Keynesian models: not yet useful for policy analysis," Staff Report 409, Federal Reserve Bank of Minneapolis.
  2. Charpe, Matthieu & Flaschel, Peter & Hartmann, Florian & Proaño, Christian, 2011. "Stabilizing an unstable economy: Fiscal and monetary policy, stocks, and the term structure of interest rates," Economic Modelling, Elsevier, vol. 28(5), pages 2129-2136, September.
  3. Diks, C.G.H. & Hommes, C.H. & Panchenko, V. & Weide, R. van der, 2006. "E&F Chaos: a user friendly software package for nonlinear economic dynamics," CeNDEF Working Papers 06-15, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  4. James Tobin, 1978. "A Proposal for International Monetary Reform," Eastern Economic Journal, Eastern Economic Association, vol. 4(3-4), pages 153-159, Jul/Oct.
  5. Carl Chiarella & Xue-Zhong He & Min Zheng, 2009. "Heterogeneous Expectations and Exchange Rate Dynamics," Research Paper Series 243, Quantitative Finance Research Centre, University of Technology, Sydney.
  6. Assenza, T. & Brock, W.A. & Hommes, C.H., 2012. "Animal Spirits, Heterogeneous Expectations and the Amplification and Duration of Crises," CeNDEF Working Papers 12-07, Universiteit van Amsterdam, Center for Nonlinear Dynamics in Economics and Finance.
  7. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  8. Carl Chiarella & Roberto Dieci & Laura Gardini & Lucia Sbragia, 2008. "A Model of Financial Market Dynamics with Heterogeneous Beliefs and State-Dependent Confidence," Computational Economics, Society for Computational Economics, vol. 32(1), pages 55-72, September.
  9. Lux, Thomas, 1995. "Herd Behaviour, Bubbles and Crashes," Economic Journal, Royal Economic Society, vol. 105(431), pages 881-96, July.
  10. Matthieu Charpe & Peter Flaschel & Florian Hartmann & Roberto Veneziani, 2012. "Towards Keynesian DSGD (isequilibrium) Modelling: Real-Financial Market Interactions with Heterogeneous Expectations Dynamics," IMK Working Paper 93-2012, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
  11. James Tobin, 1996. "A currency transactions tax, why and how," Open Economies Review, Springer, vol. 7(1), pages 493-499, March.
  12. Proaño, Christian R., 2011. "Exchange rate determination, macroeconomic dynamics and stability under heterogeneous behavioral FX expectations," Journal of Economic Behavior & Organization, Elsevier, vol. 77(2), pages 177-188, February.
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Cited by:
  1. Florian Hartmann & Peter Flaschel, 2013. "Financial Markets, Banking and the Design of Monetary Policy: A Stable Baseline Scenario," Economies, MDPI, Open Access Journal, vol. 2(1), pages 1-19, December.

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