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Expectations and Exchange Rate Dynamics: A State-Dependent Pricing Approach

  • Anthony Landry

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    (Economics Federal Reserve Bank of Dallas)

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    We introduce elements of state-dependent pricing and strategic complementarity into an otherwise standard New Open Economy Macroeconomics (NOEM) model. Relative to previous NOEM work, there are striking new implications for the dynamics of real and nominal economic activity: complementarity in the timing of price adjustment dramatically alters an open economy's response to monetary disturbances. Using a two-country Producer-Currency-Pricing environment, our framework replicates key international features following a domestic monetary expansion: (i) a high international output correlation relative to consumption correlation, (ii) a delayed overshooting of exchange rates, (iii) a J-curve dynamic in the domestic trade balance, and (iv) a delayed surge in inflation across countries. Overall, the model is consistent with many empirical aspects of international economic fluctuations, while stressing pricing behavior and exchange rate effects highlighted in the traditional work of Mundell, Fleming, and Dornbusch

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    Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 119.

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    Date of creation: 03 Dec 2006
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    Handle: RePEc:red:sed006:119
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    22. Laurence Ball & David Romer, 1987. "Real Rigidities and the Non-Neutrality of Money," NBER Working Papers 2476, National Bureau of Economic Research, Inc.
    23. Obstfeld, Maurice & Rogoff, Kenneth, 2000. "New directions for stochastic open economy models," Journal of International Economics, Elsevier, vol. 50(1), pages 117-153, February.
    24. Caballero, Ricardo J. & Engel, Eduardo M. R. A., 1993. "Microeconomic rigidities and aggregate price dynamics," European Economic Review, Elsevier, vol. 37(4), pages 697-711, May.
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