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Monetary and Fiscal Policy Under Nonlinear Exchange Rate Dynamics

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Abstract

A nonlinear exchange rate model based on the famous Dornbusch (1976) overshhoting model is modified to allow for explicit consideration of the sources of supply and demand in the foreign exchange market along the lines suggested by Kouri (1983). Imperfect substitutability between domestic and foreign assets and finite speed of adjustment are intorduced into the foreign exchnage market. Portfolio considerations dictate that the function describing the fraction of wealth domestic residents desire to hold in foreign assets be nonlinear. The exchange rate dynamics are governed by a set of nonlinear differential equations which exhibit limit cycle behaviour under perfect foresight. A number of fiscal and monetary policies are examined within the framework of the nonlinear model and compared with results with results obtained in the traditional linear mode of analysis.

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File URL: http://www.finance.uts.edu.au/research/wpapers/wp6.pdf
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Bibliographic Info

Paper provided by Finance Discipline Group, UTS Business School, University of Technology, Sydney in its series Working Paper Series with number 6.

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Length: 25 pages
Date of creation: 01 Jun 1991
Date of revision:
Publication status: Published as: Chiarella, C. 1992, "Monetary and Fiscal Policy Under Non-linear Exchange Rate Dynamics", in G. Feichtinger (ed), Dynamic Economic Models and Optimal Control, Elsevier, pp. 527-546.
Handle: RePEc:uts:wpaper:6

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References

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  1. Karacaoglu, Girol & Ursprung, Heinrich W., 1988. "Exchange rate dynamics under gradual portfolio adjustment," Journal of Macroeconomics, Elsevier, vol. 10(4), pages 565-589.
  2. Branson, William H. & Henderson, Dale W., 1985. "The specification and influence of asset markets," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 15, pages 749-805 Elsevier.
  3. Richard C. Marston, 1985. "Stabilization Policies in Open Economies," NBER Working Papers 1117, National Bureau of Economic Research, Inc.
  4. Gray, Malcolm R & Turnovsky, Stephen J, 1979. "The Stability of Exchange Rate Dynamics under Perfect Myopic Foresight," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 20(3), pages 643-60, October.
  5. William H. Branson & Willem H. Buiter, 1983. "Monetary and Fiscal Policy with Flexible Exchange Rates," NBER Working Papers 0901, National Bureau of Economic Research, Inc.
  6. Chiarella, Carl, 1986. "Perfect foresight models and the dynamic instability problem from a higher viewpoint," Economic Modelling, Elsevier, vol. 3(4), pages 283-292, October.
  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. Chiarella, Carl, 1990. "Excessive exchange rate variability : A possible explanation using nonlinear economic dynamics," European Journal of Political Economy, Elsevier, vol. 6(3), pages 315-352, December.
  9. Marston, Richard C., 1985. "Stabilization policies in open economies," Handbook of International Economics, in: R. W. Jones & P. B. Kenen (ed.), Handbook of International Economics, edition 1, volume 2, chapter 17, pages 859-916 Elsevier.
  10. George, Donald A. R. & Oxley, Leslie T., 1985. "Structural stability and model design," Economic Modelling, Elsevier, vol. 2(4), pages 307-316, October.
  11. Jacob A. Frenkel & Carlos A. Rodriguez, 1982. "Exchange Rate Dynamics and the Overshooting Hypothesis," NBER Working Papers 0832, National Bureau of Economic Research, Inc.
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Cited by:
  1. Toichiro Asada & Carl Chiarella & Peter Flaschel & Reiner Franke, 2003. "Interacting Two-Country Business Fluctuations," Working Paper Series 128, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  2. Carl Chiarella & Alexander Khomin, 2000. "Learning in a Generalized Dornbusch Model of Exchange Rate Dynamics," Working Paper Series 102, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  3. Flaschel, Peter & Sethi, Rajiv, 1999. "Stability in models of money and perfect foresight: implications of non-linearity," Economic Modelling, Elsevier, vol. 16(2), pages 221-233, April.

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