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Real exchange rate dynamics revisited: a case with financial market imperfections

  • Ippei Fujiwara
  • Yuki Teranishi

In this paper, we investigate the relationship between real exchange rate dynamics and financial market imperfections. For this purpose, we first construct a New Open Economy Macroeconomics (NOEM) model that incorporates staggered loan contracts as a simple form of the financial market imperfections. Our model with such a financial market friction replicates persistent, volatile, and realistic hump-shaped responses of real exchange rates, which have been thought very difficult to materialize in standard NOEM models. Remarkably, these realistic responses can materialize even with both supply and demand shocks, such as cost-push, loan rate and monetary policy shocks. This implies that the financial market developments is a key element for understanding real exchange rate dynamics.

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Paper provided by Federal Reserve Bank of Dallas in its series Globalization and Monetary Policy Institute Working Paper with number 62.

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Date of creation: 2010
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Handle: RePEc:fip:feddgw:62
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