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Nominal exchange rate determination and dynamics in an OLG framework

Author

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  • Mauro Bambi

    (Durham University)

  • Sara Eugeni

    (Durham University)

Abstract

The empirical evidence on nominal exchange rate dynamics shows a long-run relationship of this variable with the fundamentals of the economy, although such relationship disappears at shorter horizons. This apparently contrasting behaviour of the nominal exchange rate can be explained in an overlapping generations model where the currencies are not perfect substitutes. In this framework, we show that the nominal exchange rate is pinned down by the fundamentals at the monetary steady state. We study the local dynamics and show that when the monetary steady state is locally indeterminate, then fluctuations of the nominal exchange rate around its long-run value can emerge. In particular, we prove the existence of stationary sunspot equilibria, where random fluctuations of the nominal exchange rate arise as a result of self-fulfilling beliefs.

Suggested Citation

  • Mauro Bambi & Sara Eugeni, 2021. "Nominal exchange rate determination and dynamics in an OLG framework," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 72(1), pages 93-132, July.
    • Handle: RePEc:spr:joecth:v:72:y:2021:i:1:d:10.1007_s00199-020-01271-3
    DOI: 10.1007/s00199-020-01271-3
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    Cited by:

    1. Eisei Ohtaki, 2023. "Optimality in an OLG model with nonsmooth preferences," International Journal of Economic Theory, The International Society for Economic Theory, vol. 19(3), pages 611-659, September.

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    More about this item

    Keywords

    Nominal exchange rate determination; Nominal exchange Rate dynamics; OLG models; Sunspot equilibria;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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