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Dynamics of Endogenous Business Cycles and Exchange Rate Volatility

Author

Listed:
  • Volker Böhm
  • Tomoo Kikuchi

Abstract

This paper studies dynamics of endogenous business cycles and exchange rate volatility in a small open economy. Without market imperfections, domestic price and wage adjustments respond sluggishly to disequilibrium situations on real domestic markets while prices on international capital markets adjust instantaneously. The expectation formation mechanism under uncovered interest rate parity (UIP) induces a channel transmitting potential domestic real fluctuations into exchange rate fluctuations and vice versa. The interaction of the expectations feed back with the adjustment mechanism causes exchange rates to exhibit a higher volatility than other prices. The numerical analysis shows examples which confirm the typical empirically observed high volatility of nominal exchange rates compared with that of real/domestic variables.

Suggested Citation

  • Volker Böhm & Tomoo Kikuchi, 2002. "Dynamics of Endogenous Business Cycles and Exchange Rate Volatility," CESifo Working Paper Series 797, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_797
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    File URL: http://www.cesifo-group.de/DocDL/cesifo_wp797.pdf
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    References listed on IDEAS

    as
    1. Maurice Obstfeld & Kenneth Rogoff, 2001. "The Six Major Puzzles in International Macroeconomics: Is There a Common Cause?," NBER Chapters,in: NBER Macroeconomics Annual 2000, Volume 15, pages 339-412 National Bureau of Economic Research, Inc.
    2. Lane, Philip R., 2001. "The new open economy macroeconomics: a survey," Journal of International Economics, Elsevier, pages 235-266.
    3. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
    4. Barro, Robert J & Grossman, Herschel I, 1971. "A General Disequilibrium Model of Income and Employment," American Economic Review, American Economic Association, vol. 61(1), pages 82-93, March.
    5. V. V Chari & Patrick J. Kehoe & Ellen R. McGrattan, 2002. "Can Sticky Price Models Generate Volatile and Persistent Real Exchange Rates?," Review of Economic Studies, Oxford University Press, vol. 69(3), pages 533-563.
    6. Jean-Pascal Benassy, 1975. "Neo-Keynesian Disequilibrium Theory in a Monetary Economy," Review of Economic Studies, Oxford University Press, vol. 42(4), pages 503-523.
    7. Betts, Caroline & Devereux, Michael B., 2000. "Exchange rate dynamics in a model of pricing-to-market," Journal of International Economics, Elsevier, vol. 50(1), pages 215-244, February.
    8. Kollmann, Robert, 2001. "The exchange rate in a dynamic-optimizing business cycle model with nominal rigidities: a quantitative investigation," Journal of International Economics, Elsevier, vol. 55(2), pages 243-262, December.
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