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Exchange Rate Volatility: The Role of Real Shocks and the Velocity of Money

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  • Salyer, Kevin D

Abstract

The effects of stochastic output shocks on the behavior of exchange rates and nominal price levels is studied within the context of a two-country, cash-in-advance model. The analysis of this model, in contrast to the existing cash-in-advance literature, demonstrates that exchange rates can be more volatile than price levels even though agents' elasticity of substitution between foreign and domestic goods is greater than one-half. This possibility arises when output shocks are autocorrelated and are due to revisions in expectations that affect the terms of trade and/or the velocity of money. Copyright 1989 by Oxford University Press.

Suggested Citation

  • Salyer, Kevin D, 1989. "Exchange Rate Volatility: The Role of Real Shocks and the Velocity of Money," Economic Inquiry, Western Economic Association International, vol. 27(3), pages 387-409, July.
  • Handle: RePEc:oup:ecinqu:v:27:y:1989:i:3:p:387-409
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