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Exchange Rate Expectations Redux and Monetary Policy

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  • Christian Pierdzioch

Abstract

This paper uses a dynamic general equilibrium optimizing two-country model to analyze how the formation of exchange rate expectations shapes the effects of monetary policy shocks in open economies. The model implies that the short-run output effects of permanent monetary policy shocks diminish if 'noise traders' in the foreign exchange market form regressive exchange rate expectations. If the influence of these noise traders is strong enough, a permanent expansionary monetary policy shock can result in a temporary decline of the output in the country in which it takes place. The output effects of temporary monetary policy shocks are magnified when noise traders form regressive exchange rate expectations.

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Bibliographic Info

Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1109.

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Length: 32 pages
Date of creation: May 2002
Date of revision:
Handle: RePEc:kie:kieliw:1109

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Keywords: Monetary policy; Exchange rate expectations; Noise trading;

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  1. Dornbusch, Rudiger, 1976. "Exchange rate expectations and monetary policy," Journal of International Economics, Elsevier, Elsevier, vol. 6(3), pages 231-244, August.
  2. M.B. Devereux & Ch. Engel, 2003. "Exchange Rate Pass-Through, Exchange Rate Volatility, and ExchangeRate Disconnect," DNB Staff Reports (discontinued), Netherlands Central Bank 77, Netherlands Central Bank.
  3. Allen, Helen & Taylor, Mark P, 1990. "Charts, Noise and Fundamentals in the London Foreign Exchange Market," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 100(400), pages 49-59, Supplemen.
  4. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  5. Frankel, Jeffrey A & Froot, Kenneth A, 1990. "Chartists, Fundamentalists, and Trading in the Foreign Exchange Market," American Economic Review, American Economic Association, American Economic Association, vol. 80(2), pages 181-85, May.
  6. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1131, C.E.P.R. Discussion Papers.
  7. Menkhoff, Lukas, 1997. "Examining the Use of Technical Currency Analysis," International Journal of Finance & Economics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 2(4), pages 307-18, October.
  8. Dornbusch, Rudiger, 1976. "Expectations and Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 84(6), pages 1161-76, December.
  9. Frankel, Jeffrey A. & Froot, Kenneth A., 1987. "Short-term and long-term expectations of the yen/dollar exchange rate: Evidence from survey data," Journal of the Japanese and International Economies, Elsevier, vol. 1(3), pages 249-274, September.
  10. Sutherland, Alan, 1996. " Financial Market Integration and Macroeconomic Volatility," Scandinavian Journal of Economics, Wiley Blackwell, Wiley Blackwell, vol. 98(4), pages 521-39, December.
  11. Frankel, Jeff & Froot, Ken, 1986. "Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations," Department of Economics, Working Paper Series, Department of Economics, Institute for Business and Economic Research, UC Berkeley qt1972q8wm, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  12. Sergio Da Silva, 2001. "Chaotic Exchange Rate Dynamics Redux," Open Economies Review, Springer, Springer, vol. 12(3), pages 281-304, July.
  13. Klein, Paul, 2000. "Using the generalized Schur form to solve a multivariate linear rational expectations model," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 24(10), pages 1405-1423, September.
  14. Niehans, Jurg, 1975. "Some doubts about the efficacy of monetary policy under flexible exchange rates," Journal of International Economics, Elsevier, Elsevier, vol. 5(3), pages 275-281, August.
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