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

Habib Ahmed (), Paul Hallwood () and Stephen M. Miller ()

No 2006-15, Working papers from University of Connecticut, 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)
New Economics Papers: this item is included in nep-cba, nep-fin, nep-fmk, nep-ifn, nep-mac and nep-mon
Date: 2006-06, Revised 2009-01
Note: This paper previously circulated under the title "Monetary Policy, Exchange Rate Overshooting, and Endogenous Physical Capital".
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Forthcoming in Keio Economic Studies

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Related works:
Working Paper: The Exchange Rate-Investment Nexus and Exchange Rate Instability: Another Reason for ‘Fear of Floating’ (2009)
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Persistent link: http://EconPapers.repec.org/RePEc:uct:uconnp:2006-15

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