Expectations and Exchange Rate Policy

Michael Devereux and Charles Engel

No 62007, Working Papers from Hong Kong Institute for Monetary Research

Abstract: Both empirical evidence and theoretical discussion has long emphasized the impact of ¡¥news¡¦ on exchange rates. In most exchange rate models, the exchange rate acts as an asset price, and as such responds to news about future returns on assets. But the exchange rate also plays a role in determining the relative price of non-durable goods. In this paper we argue that these two roles may conflict with one another when nominal goods prices are sticky. If news about future asset returns causes movements in current exchange rates, then when nominal prices are slow to adjust, this may cause changes in current relative goods prices that have no efficiency rationale. In this sense, anticipations of future shocks to fundamentals can cause current exchange rate misalignments. We outline a series of models in which an optimal policy eliminates news shocks on exchange rates.

Pages: 31 pages
Date: 2007-03
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mac and nep-mon
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Citations: View citations in EconPapers (3)

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Related works:
Working Paper: Expectations and Exchange Rate Policy (2006)
Working Paper: Expectations and Exchange Rate Policy (2006)
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