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Imperfect Information and the Comovement of the Exchange Rate and the Interest Rate: A Signal Extraction Approach

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  • Takagi, Shinji

Abstract

This paper analyzes the joint determination of the exchange rate and the interest rate in a signal extraction framework. In principle, a given disturbance should generate a systematic relationship between the exchange rate and the interest rate, as two endogenous variables, in the context of any specified economic model. When expectations matter, however, the introduction of imperfect information would weaken the comovement between the two endogenous variables that results from a given disturbance. This simple point is demonstrated in a flexible-price model of a small economy. Copyright 1991 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Suggested Citation

  • Takagi, Shinji, 1991. "Imperfect Information and the Comovement of the Exchange Rate and the Interest Rate: A Signal Extraction Approach," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 32(4), pages 1023-1035, November.
    • Handle: RePEc:ier:iecrev:v:32:y:1991:i:4:p:1023-35
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    Cited by:

    1. Philippe Bacchetta & Eric van Wincoop, 2011. "Modeling Exchange Rates with Incomplete Information," Cahiers de Recherches Economiques du Département d'économie 11.03, Université de Lausanne, Faculté des HEC, Département d’économie.

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