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Long-run consequences of finite exchange rate bubbles

  • Alessandra Pelloni

This paper draws on the literature on exchange rate instability and on sunk-cost hysteresis to analyze the long-run effects of exchange rate bubbles. To address the issue, after discussing the implications of sunk-cost hysteresis for aggregate supply, we propose two versions of the Dornbusch (1976) model of exchange rate determination. We modify it so as to allow for endogenous adjustment in productive capacity, with the aggregate investment function being linear with respect to the exchange rate in one version and non-linear in the other. For both versions, we provide solutions for a Blanchard-type bubble developing on the foreign exchange market. We find that, if capacity adjusts non-linearly, such a bubble will affect the steady state of the economy. Copyright Kluwer Academic Publishers 1993

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Article provided by Springer in its journal Open Economies Review.

Volume (Year): 4 (1993)
Issue (Month): 1 (March)
Pages: 5-26

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Handle: RePEc:kap:openec:v:4:y:1993:i:1:p:5-26
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  1. Richard Baldwin & Paul R. Krugman, 1986. "Persistent Trade Effects of Large Exchage Rate Shocks," NBER Working Papers 2017, National Bureau of Economic Research, Inc.
  2. L. Wade, 1988. "Review," Public Choice, Springer, vol. 58(1), pages 99-100, July.
  3. Rudiger Dornbusch and Jeffrey Frankel., 1988. "The Flexible Exchange Rate System: Experience and Alternatives," Economics Working Papers 8868, University of California at Berkeley.
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  13. Schmalensee, Richard., 1980. "Product differentiation advantages of pioneering brands," Working papers 1140-80., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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  17. Dixit, A., 1988. "Entry And Exit Decisions Under Uncertainty," Papers 91, Princeton, Department of Economics - Financial Research Center.
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  19. Richard Baldwin & Richard Lyons, 1989. "Exchange Rate Hysteresis: The Real Effects of Large vs Small Policy Misalignments," NBER Working Papers 2828, National Bureau of Economic Research, Inc.
  20. Mark, Nelson C., 1990. "Real and nominal exchange rates in the long run: An empirical investigation," Journal of International Economics, Elsevier, vol. 28(1-2), pages 115-136, February.
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