Real Exchange Rate Overshooting and the Output Cost of Bringing Down Inflation
In: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics
The proposition that under a floating exchange rate regime restrictive monetary policy can lead to substantial "overshooting" of the nominal and real exchange rate is now accepted fairly widely. The fundamental reason is the presence of nominal stickiness or inerta in domestic factor and product markets combined with a freely flexible nominal exchange rate. Current and anticipated future monetary policy actions are reflected immediately in the nominal exchange rate, set as it is in a forward-looking efficient auction market while they are reflected only gradually and with a lag in domestic nominal labour costs and / or goods prices. Nominal appreciation of the currency therefore amounts to real appreciation - a loss of competitivensss. Since in most of the simple analytical models used to analyse the overshooting propositions there is no long-run effect of monetary policy on the real exchange rate, any short-run real appreciation implies an overshooting of the long-run equilibrium. The transitory (but potentially quite persistent) loss of competitiveness is associated with a decline in output below its capacity level. This excessive capacity is one of the channels through which restrictive monetary policy brings down the rate of domestic cost and price inflation.
(This abstract was borrowed from another version of this item.)
|This chapter was published in: ||This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number
11682.||Handle:|| RePEc:nbr:nberch:11682||Contact details of provider:|| Postal: |
Web page: http://www.nber.org
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- James Tobin, 1977.
"How Dead is Keynes?,"
Cowles Foundation Discussion Papers
458, Cowles Foundation for Research in Economics, Yale University.
- Sargan, J D, 1980. "A Model of Wage-Price Inflation," Review of Economic Studies, Wiley Blackwell, vol. 47(1), pages 97-112, January.
- Kravis, Irving B. & Lipsey, Robert E., 1978.
"Price behavior in the light of balance of payments theories,"
Journal of International Economics,
Elsevier, vol. 8(2), pages 193-246, May.
- Irving B. Kravis & Robert E. Lipsey, 1977. "Price Behavior in the Light of Balance of Payments Theories," NBER Working Papers 0181, National Bureau of Economic Research, Inc.
- Willem H. Buiter & Marcus H. Miller, 1980. "Monetary Policy and International Competitiveness," NBER Working Papers 0591, National Bureau of Economic Research, Inc.
- Liviatan, Nissan, 1980. "Anti-Inflationary Monetary Policy and the Capital Import Tax," The Warwick Economics Research Paper Series (TWERPS) 171, University of Warwick, Department of Economics.
- Isard, Peter, 1977. "How Far Can We Push the "Law of One Price"?," American Economic Review, American Economic Association, vol. 67(5), pages 942-48, December.
- Minford, Patrick, 1980. "A rational expectations model of the United Kingdom under fixed and floating exchange rates," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 12(1), pages 293-355, January.
- Buiter, Willem H, 1978. "Short-run and Long-run Effects of External Disturbances under a Floating Exchange Rate," Economica, London School of Economics and Political Science, vol. 45(179), pages 251-72, August.
When requesting a correction, please mention this item's handle: RePEc:nbr:nberch:11682. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ()
If references are entirely missing, you can add them using this form.