The Exchange Rate-Investment Nexus and Exchange Rate Instability: Another Reason for ‘Fear of Floating’

Habib Ahmed (), Paul Hallwood () and Stephen Miller
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Paul Hallwood: Department of Economics, University of Connecticut

No 918, Working Papers from University of Nevada, Las Vegas , Department of Economics

Abstract: We show that expansionary monetary policy causes exchange rate overshooting due to the secondary repercussion comes through the reaction of firms to changed asset prices and the firms’ decisions to invest in real capital. This overshooting effect adds to any overshooting that occurs through the traditional Dornbusch (1976) channel, since our model with its market clearing in the short run excludes any Dornbusch overshooting. The model sheds further light on the volatility of real and nominal exchange rates. It suggests that changes in corporate sector profitability may affect exchange rates through international portfolio diversification in corporate securities, and it offers an additional reason for ‘fear of floating’.

Keywords: exchange rates; open economy macroeconomics; monetary policy; exchange rate overshooting (search for similar items in EconPapers)
JEL-codes: F31 F32 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2009-03
New Economics Papers: this item is included in nep-cba, nep-ifn, nep-mon and nep-opm
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Published in Keio Economic Studies, 2008

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Working Paper: The Exchange Rate-Investment Nexus and Exchange Rate Instability: Another Reason for 'Fear of Floating' (2009)
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